Name one thing you would buy if you had $100. Nike Mercurial Vapor VII (soccer shoes)

How much money do you think it takes to be considered “rich”? $3,000,000

Would you consider our family “rich”? Yes.

What job do you want to do when you grow up? A cleat designer (someone who designs soccer shoes)

How much do you think that job will pay? $300,000 a year.

How much do you think a new house costs? $145,125 (He's a bit low for our area, but unfortunately this isn't far off the value of our house at this point in time)

At what age do you think people retire? 65

How much do you think people need to have saved up for retirement? $4,000,000

FMF’s daughter – age 13

What is money? Special paper that you can use to buy things.

Where does money come from? US Mint.

Name one thing you would buy if you had $100. Something I probably wouldn't need.

How much money do you think it takes to be considered “rich”? Around $1,000,000.

Would you consider our family “rich”? Compared to some people.

What job do you want to do when you grow up? Writer, photographer, interior designer, the list goes on...

How much do you think that job will pay? Depends on the job. $50,000 a year or higher.

How much do you think a new house costs? Maybe about $100,000.

At what age do you think people retire? 60 to 65

How much do you think people need to have saved up for retirement? $1,000,000 or maybe more. It depends on how long you are planning on living.

I was actually pretty impressed -- they knew far more about money than I thought. I think some of that is because we talk about it often and some is because we watch and discuss financially-related shows (like Income Property, House Hunters International, Shark Tank, and so on.)

So what about your kids -- how do you think they would answer? If you'd like to ask them and email me the answers, I'll post some of them here on FMF.

Last time we discussed calculating your lifetime savings percentage, a concept I wasn't really that impressed by. But I'm reserving judgment because I think they are leading us down a careful path. And today's step is another move along that journey.

Step #2 actually has two parts as follows:

Establish the actual costs in time and money required to maintain your Job (yes, they capitalize "job"), and compute your real hourly wage.

Keep track of every cent that comes into and goes out of your life.

Your Real Hourly Wage

One of the main thoughts preceding step #2 is the following:

Money is something we choose to trade our life energy for.

In other words, we all only have so much time (life) here on earth. Someone (or more than one) in each family trades part of his/her time in exchange for money, so the family can survive. They are literally giving up their lives to get money.

So, how much money are you getting in exchange for your life? It's a lot less than you think -- which is the exact point of computing your real hourly wage.

Why is it a lot less than you think? Because there are a myriad of costs associated with you working -- commuting costs, clothing costs, meals, and on and on. The book even assigns costs to things like "daily decompression" and "escape entertainment" as expenses associated with working. In addition, there is time associated with each of these, making the time devoted to work much more than most people assume. The net impact is that you're actually making less than you think while spending more time to do it.

Once all costs are deducted from the amount you're paid and hours added in for other job-related tasks, you only bring home a fraction of your paycheck while working much more than you think. When you divide the net amount earned by the total hours work requires, it's a rather sobering experience. You see your net proceeds for giving up an hour of your life, and the result isn't encouraging. This is exactly what the book wants you to realize -- that you're getting far less than you think in exchange for your life energy.

I realize that this process might be a bit confusing when described in words, so here's a chart from the book that may add some clarity:

So the point is that while you think you're earning $17 per hour, your job is actually delivering $6 per hour. It's a big wake-up call, huh?

I have two responses to this exercise:

Yes, there are extra costs and time associated with working that most of us don't take into account when we think about how much money (and for what time) our jobs deliver. This is why it's often easier than most people think to go from two incomes to one.

The information above might be a bit over-board. After all, you're going to have to eat even if you don't have a job, right? So is that time really gained if you don't have a job? I actually spend less time eating when I'm at work (I usually eat at my desk) than I do when I'm home with my family.

This said, they have a good point. There are costs associated with working -- in both time and money. And it might be (I'm not sold on it yet) worth the effort to figure out just how much you really make per hour.

It's the best way to become conscious of how money actually comes and goes in your life as opposed to how you think it comes and goes.

I agree. I've had people do this exercise time and time again (as part of counseling I'm done) and they are ALWAYS surprised in one way or another. They discover places they never knew where money was leaking out of their lives -- and it all added up to a pretty good sum over time. Without tracking spending by the penny they would have never known this.

The book doesn't give a time period for tracking your money by the cent and I'm thinking they mean for it to become a life-long habit. This is a bit over-board for me to recommend as a widespread practice (even though our family tracks pretty close to every penny -- through Quicken -- that we spend). I suggest people track every cent they spend for 30 days as a step toward developing an accurate cash flow plan. From there they may want to repeat a 30-day tracking once or twice a year, though a regular tracking system (like using Quicken or Mint) will handle much of what you'll find by writing down every penny spent in a notebook.

It’s important to step back and really think about what you want—not just your next job or your next house or your next trip. If you fast-forward twenty years and then look back, what will make you feel good about how you spent those twenty years? Real success is personal. It’s not what anyone else wants for or expects from you.

Often people have trouble coming up with the answer to the question, “What does success really mean to you?” They don’t have a particular goal. If you want to be a CEO by a certain age, or have a particular amount of money in the bank by a certain date, those are fairly concrete goals. But if you don’t have really clear goals, how do you answer the question?

Your True Desired Outcome

Try thinking more generally about what you want to make come true in your life. Do you want to have adventures? Do you want to pass your values on to your children? Do you want to spend lots of time in nature? Do you want to be with really smart people? Really think about what you want to make sure happens in your life. That is the root of your true desired outcome.

Your true desired outcome is true to you. It’s not what it is “supposed to be.” It’s not what your family or your colleagues think you should be doing. It is not all about work. It is about work and life and what you really want to make happen overall in your life.

Why is this useful? Because plans don’t work. It is impossible to plan a sequence of steps in your career over ten or twenty years. But establishing a true desired outcome for your career and life is really helpful. Here’s why.

You Avoid Wasting Time

The more clear you can be about your true desired outcome, the more clear you can be in the moment about whether or not you are wasting your time. You can ask, “Is my role building capital to achieve my desired outcome or degrading it?” It lets you make judgments at different points to see if what you are doing in the moment is helpful, neutral, or damaging to achieving your desired outcome in life.

The great benefit of having this defined is not that it prescribes a specific plan, but that, in tough and confusing times, it gives you a picture to fall back on—a vision of what all this effort and activity is supposed to amount to.

As an example, I once left a job that I loved. I loved my boss; my boss loved me. I loved my team; my team loved me. We were doing great. But one morning I woke up and thought to myself, “Damn! I am starting to waste time here. If I spend any more time in this lovely job, I am missing an opportunity to build the career capital and the experience I need to become a CEO.”

I ended up going after what turned out to be the worst job I’ve ever had. It was a turnaround situation in a failing business where everyone was angry. For the first six months I was completely miserable, but because this job required me to be in charge of strategy, marketing, and sales generation globally, it was exactly the kind of experience I needed to become a CEO.

So, as hard as it was, I made the tradeoff between a happy, fun job, and the experience I needed to attain my desired outcome. I felt good about it because I made the choice on purpose, and it helped me survive the low points.

We ultimately turned the business around and it became a great job—in fact, it was my last job before becoming a general manager. But I never would have left my happy job if I had not had a desired outcome defined, causing me to assess my situation and question it.

This choice to move from a happy but safe to an ugly but high-impact job serves as a great example of how having defined my big desired outcome allowed me to make decisive and effective choices and tradeoffs in my career. The CEO outcome served me very well for many years. Ultimately, after achieving that goal, I decided to incorporate more life-oriented goals into my big-picture desired outcome. I realized that I had a broader desired outcome than operating as the head of a single company.

The Hard Part—There Is Conflict

There is inherent conflict in fitting your job into your life. Say you want to have a big career and make a lot of money, or make a difference in the world, but you want to spend time with your family and enjoy your life outside of work too. You feel like these are in conflict.

Or you really don’t enjoy your work and really just want to be spending your time doing other things.

Both of these situations result in constantly questioning: Am I doing the right thing?

I know people who second-guess themselves for years and years, either feeling guilty about working a lot, feeling resentful that their success is limited by their family obligations, or feeling depressed that their job is sapping all the life out of their life.

Unless you are already independently wealthy, you need to be earning an income to pay the bills and fund your fun. But you don’t need to let the fact that you need to earn money ruin your whole life.

Many people feel unhappy because they try to optimize everything at once, and the resulting failure to do so feels bad. In reality, having a desired outcome defined is not magically going to eliminate the need for a paycheck or give you double the time to do what you want to do in work and life. But it does let you make decisions and tradeoffs on purpose. And that not only makes it feel a lot better and less stressful, but also helps you to

Make much better judgments about how you are spending your time and whether it is amounting to anything—so you can proactively avoid wasting time, stuck in a job that is not helping you.

Make some tradeoffs on purpose, so you feel like you are more in control of the outcome and not questioning yourself all the time.

Make Tradeoffs on Purpose

The clearer you can be about what you really want in your work and your family life, the more easily you can make tradeoffs on purpose. And you can make different tradeoffs at different times.

Let’s face it. There will be times in your career that you will cancel your vacation to deal with a launch or a customer issue, and other times that you won’t. If you are clear about your outcome, you can make those choices on purpose—different priorities at different times.

You can sometimes work “too much” for good reasons, and at other times you can pass up work opportunities in favor of family. And along the way you can prioritize small things that keep you connected with your family, even if you can’t spend as much time as you want with them sometimes. When you make choices for reasons that serve your desired outcome, you feel much more in control and much more satisfied.

You can also recruit your family to be on your side if you share your thoughts about what all this work and money is for. What is it amounting to? This shared understanding of your true desired outcome can relieve you of huge amounts of stress.

Balance, No—Purpose, Yes

I’m sorry, but balance just doesn’t work. Particularly if you are ambitious. You are going to work very hard and focus on your career at the expense of the rest of your life from time to time.

However, building your career and letting your life go to hell does not work either. The trick is, if you want to do better at either work or life, you need to get better at both.

If this seems impossible, just think about it this way. If your work is making you miserable, you won’t be good to your family, and if your family is making you miserable, you won’t be as good at your work. The only way out of this is to force yourself to get incrementally better at both.

If your family is a source of strength, you can apply even more energy to your work. And if you are handling your job with ease and grace, you will have more energy to be good to your family.

Don’t Make It Such a Competition

Try to think of work and life as mutually reinforcing instead of in competition.If you are doing great in your career but your family is unhappy or your life has no life in it, you have the constant stress of causing disappointment, or outright arguing, and feeling guilty about your family and time outside of work. That energy drain is keeping you from fully optimizing your career.

One of my favorite stories is about a colleague, a very ambitious hard-working woman in her thirties. Her husband is a gifted school teacher. She is investing a lot of time and energy in building her career, and her husband is doing good in the world with his teaching and supporting her every step of the way.

On the day when a new blockbuster movie came out, he called her at work around noon and said, “I’d really like to go see the movie today on opening day.” She looked at her workload and said, “Sorry, I have to work late.” Instead of being disappointed, getting upset, and giving her a hard time, here is what he did. He said, “The last showing is at 9:30 p.m. If we meet at the movie theater, can you make it?” After she agreed, here is what he did: He cleaned the whole house and packed her a dinner. He put it in a fancy shopping bag with a silk scarf over it, so the movie theater would not see that it was food and would let her bring it in.

That is a picture of a couple whose life and work are both working!

Don’t Zero Out

There is finite time in the day, week, and month. Even if you are optimizing for work, it is important to not let the rest of your life zero out completely.

KEY INSIGHT: There is a much bigger difference between doing nothing and doing something small, than between doing something small and something big.

If there is something you want to be doing and you’re not doing it at all, the feeling of zero feels really bad. But the feeling of something, even if it’s small, stops that really bad feeling of zero.

People tend to set themselves up to think if they can’t do the big thing, then life is bad. If you love to travel the world, but your work or family prevents it, then you are miserable. But why not go away for a weekend somewhere once or twice a year?

Or if you really crave some peace and quiet and time to think, but can’t get away, go sit in your car for fifteen minutes every day.

There is a huge difference between zero and something. You can always do something.

I was talking to a very senior consultant whose job kept him on the road virtually all the time, including weekends, when he would travel to and from clients. He felt like he was getting no time at all with his family. The big thing he wanted was to spend lots of evenings and weekends with his family. That was just not going to happen in this job. So he told his firm that one weekend a quarter would be his. The difference between zero and something makes a big psychological difference for you and your family.

Later he made another career choice, to optimize the time he spent with his family.

You can’t optimize everything all at once, but you can make sure you don’t zero out.

You can easily trade off some work time for some life time. These days, for an increasing number of people, it is very easy to work outside the office. Tell your boss that you are going to come it at 11:00 on Wednesday, and take your partner out to breakfast. Trade a weekday to go on a school trip, then do some work on a weekend.

It’s Up to You to Be OK

Part of your job is to figure out how to not be fully consumed and burned out. The better you get at your job, the more you can get done in a shorter amount of time with less effort and energy. You’ll then have more time and energy to do things outside of work.

You need to take responsibility to make time to do the things over and above your job description that will make you successful, including claiming some time to get better at your home life. Your company wants you to have a good life that you enjoy. They know they will get more out of you at work if you are happy outside of work.

May 29, 2012

If you want to know how tall someone is, you have them stand on a level surface, back against a wall, then make a mark on the wall and get out a tape measure. If you want to know how much someone weighs, you have them stand on a properly calibrated scale. Simple, right?

But what if you wanted to measure someone’s financial condition? When I said earlier that our goal is to achieve a strong financial position, what did I mean by that? How is personal financial strength measured? What is the equivalent of inches or pounds when it comes to personal financial health?

It’s an important question, because you won’t be able to tell if you’re succeeding unless you’ve got a way to measure your progress. To find your way using a map, the first step is identifying the you-are-here point—and knowing where you are requires a measurement.

The way we measure personal financial health is called net worth. Net worth isn’t an opinion or an impression; it is a very well-defined measure with a specific definition that is widely accepted. We’ll describe how to calculate it shortly, but before we do, most people find it helpful to understand it conceptually first—and for that, we need an analogy.

The Net Worth Bathtub

Think of an ordinary bathtub. When you turn on the faucet, water runs into the bathtub. The water will stay in the tub until the drain is opened. This tub has a really big drain, and it is adjustable. So it is possible to drain the water out more slowly than it is coming in, faster than it is coming in, or at exactly the same rate. Got it?

You’ve probably already figured out that the faucet represents money coming in. This is income from all sources: the paycheck from your job or jobs, your lottery winnings, gift checks from your grandparents, whatever. The drain, of course, is money going out: paying your bills, buying airplane tickets, money in wallets that you lose, and so on. Obviously, when water is coming into the tub faster than it is draining out, the water level in the bathtub will rise; when water is draining out faster than it is coming in from the faucet, the water level will fall.

Now here is the point: when it comes to personal financial management, what we care about most is the water level in the bathtub. The water level in an individual’s bathtub represents that person’s net worth. Other terms for a high water level are rich or wealthy. So the object of the game is to increase your net worth. Fill up that bathtub! All that we have talked about, and will talk about, are strategies to increase your net worth. Any financial decision that you make should be made with net worth in mind.

Some very important realizations are apparent from the bathtub analogy; in fact, they’re so obvious that they hardly need to be pointed out. If you want the water level in the bathtub to rise, then the drain has to be adjusted to a rate that is slower than the faucet is running. And the longer the drain is running slower than the faucet, the higher the water will rise. Stated a different way, it isn’t the absolute rate that the drain and faucet are running that is important—it is the relationship between the two.

Common Misconceptions

Even though these implications are quite readily apparent when it comes to bathtubs, it is amazing how murky people’s thinking can get when applying the same ideas to personal finance. The two most common misconceptions are to confuse either the faucet or the drain with the water level. Let’s look at them one at a time:

Misconception #1: The faucet is all that matters. A fast-running faucet means a really high income, right? In many different ways, the faucet gets so much publicity that it is easy to see how some people get the idea that this is really the only important goal. In our culture, a high income is regarded as prestigious or even glamorous. Controlling expenses and being thrifty (or watching the drain closely) are often regarded as the opposite—only for those with very low incomes.

Anytime income tax rates are in the news, the news media like to refer to people in the higher income tax brackets as “the rich.” This serves to further the misconception that high income automatically means high net worth.

High earners in the upper tax brackets may or may not have parlayed that high income into substantial wealth; it depends on how well—or not—they have managed their drain.

Misconception #2: The drain is all that matters. A fast-running drain means lots and lots of spending. If we see someone who is driving a luxury car, maybe even has a few extra cars, lives in an expensive home, and takes a lot of extravagant vacations, it is not uncommon to hear their neighbors conclude, “Oh, that person is really rich!” (In fact, one of the main reasons that this person buys all those things may be precisely because he or she wants the neighbors to say that.)

The idea that a wide-open drain is proof of a full bathtub is regularly reinforced culturally, too. It is a favorite theme of advertisers; after all, it doesn’t do the advertiser any good when you tighten your drain controls. Their job is to get you into a “spend spend spend” frame of mind. It’s also a favorite theme in most popular entertainment. A rich-looking hero speeding away from his or her mansion in an ultra-hot sports car probably captures your attention a little better than one who is huddled over a spreadsheet, intently preparing next month’s budget. Just remember: your financial life is not fictional. Advertisers and media have their agendas, and that’s fine—you have your own.

Despite these misconceptions, the truth is pretty easy to understand when you think about the bathtub analogy. Neither the faucet, nor the drain, is the be-all and end-all when it comes to increasing net worth; it is the relationship between the two. A fast-running faucet provides a better opportunity to increase net worth, but it won’t happen without proportionate drain control. Watching expenses carefully may not be portrayed as something that wealthy people need to be concerned with, but controlling spending is essential to building a high net worth.

A famous book titled The Millionaire Next Door by Thomas J. Stanley featured detailed, survey-based descriptions of the lifestyles of the wealthiest people in the United States. In fact, the subtitle of the book is The Surprising Secrets of America’s Wealthy. By now, you might be able to guess what the surprise is: the most common profile of America’s wealthy does not conform to either the big faucet or the big drain stereotype. In fact, it is surprisingly common for those with big faucets to fall into a big-drain habit that leaves them with only modest water levels. Instead, it is quite a bit more common for wealth to be built by consistent drain control. Most of America’s wealthy turn out to live in much less expensive homes than they could afford, to buy used cars, and to generally avoid any spending that could be considered extravagant.

Does this surprise you? It is certainly a very different picture than the way that “wealthy” is usually portrayed in the popular culture. But it makes sense when you think about it, using the bathtub analogy. In a way, it is a classic illustration of the old saying “You can’t have your cake and eat it, too.” America’s wealthy have their cake. America’s biggest spenders have eaten most of theirs, and now it’s gone.

Take a minute to think about this . . . it is really important for this point to sink in. Once it does sink in, you’ll never think about spending money in the same way again. You’ll stop associating spending with what it can buy you today; instead, you’ll view spending as lost opportunities to save, invest, and grow your net worth. This way of thinking will then become a powerful transformational habit for you. If you want the freedom to retire early, or to weather any kind of unanticipated financial storm, or to be in a position to help those close to you if needed, you’ll want to have most of your cake left. That means that you’ll have to keep a careful eye on how much of it you eat—plain and simple.

May 28, 2012

Just wanted to say Happy Memorial Day to everyone (it's a holiday where we remember the service and sacrifice of those who have given their lives for our country.) Like most others in the U.S., I'm taking the day off -- I'll be back tomorrow.

In addition to those who have paid the ultimate sacrifice for America, I like to remember and thank all our veterans, enlisted personnel, officers, and their families on this day. Words are inadequate to express our great appreciation for your service.

Of course, there are a few different thoughts on how much you should monitor your giving (whether to a church or other organization). Generally these boil down to the following:

I am a steward of what God gives me and as a result I am responsible for how the dollars I give are spent. Therefore I want to know EXACTLY how my money is spent.

Yes, I am a steward, but I am giving my gift to a trusted organization and while I generally know how they spend the money, I do not know where every penny goes.

I give and trust God will use the money for His purposes. I don't have much of a knowledge where the money goes.

Personally, I try to be in the second point's range with all my giving. For instance, our church has an annual business meeting where they present the financial results for the previous year (audited, by the way) and questions are asked. I don't know where every penny goes (nor do I want to), but I have a good sense of how the overall spending breaks down. I'm fine with that.

I also have a couple organizations I work with either as a board member, advisor, or committee member. I know a good amount about their operations and am comfortable with their spending (and my giving) as a result.

On the other hand, there are national groups that I really don't know many details about -- I just have a general sense of what they do. For instance, I know that Habitat for Humanity builds homes for those who need/can't afford them, but that's the end of my knowledge. But I still give to them because they are (in my eyes) a trusted source of charitable work and have been rated such by impartial organizations.

So I try to get as much information as I can about an organization and then base my give/no give decision accordingly, depending on what I know and what sort of charitable efforts I want to support at the time.

How about you? How much do you need to know before you give to a charity?

May 26, 2012

A gone-fishing portfolio has a limited number of investments with a balanced asset allocation that should do well with dampened volatility. Its primary appeal is simplicity. As a secondary virtue, it avoids the worst mistakes of the financial services industry. This year I limited myself to 12 investment vehicles.

Asset allocation begins by selecting the top six asset categories. A good starting point is an age-appropriate allocation. We use as our example a couple both born in 1972 and turning 40 this year. The most popular names of that era were Michael and Jennifer. Their age-appropriate allocation will be 3% short money, 5.8% U.S. bonds, 5.8% foreign bonds, 32.2% U.S. stocks, 36.2% foreign stocks and 17.0% hard asset stocks. (Click to enlarge chart.)

Short money matures in less than two years. Often simply kept in the money market, it can be tapped for emergencies during the accumulation phase or used as a pool for spending during the distribution phase. Michael and Jennifer will put 3% in short money.

Last year I chose a single exchange-traded fund (ETF) representing the entire bond market. This year I suggest two holdings as the best prospects for U.S. bonds and foreign bonds, respectively. PIMCO Total Return (PTTDX/PTTRX) looks for yield wherever it may be on the yield curve. PIMCO Emerging Markets Bond (PEMDX/PEBIX) has a 4.72% yield. Michael and Jennifer will invest 5.8% in each.

In the next few columns, I will explain why these two bond funds are appropriate choices for each category and why I chose mutual funds this year instead of ETFs.

U.S. debt and deficit is enormous. We sit squarely in what investment author Bill Gross calls the ring of fire. We are also burdening businesses with needless regulation and steep tax increases that will continue to stunt economic growth. On the brighter side, the United States is still mostly free according to the Heritage Foundation's Index of Economic Freedom. For these reasons, we recommend investing more in foreign stocks in countries with less debt and deficit than the United States but still investing here.

We normally suggest tilting small and value to boost returns. But this year the projected price-to-earning ratios favor a large blend. Therefore we advise mostly investing according to the S&P 500. We recommend splitting your U.S. stock allocation 80% in the Vanguard S&P 500 ETF (VOO) and 20% in the Vanguard Information Technology ETF (VGT). For Michael and Jennifer that would mean 25.8% in VOO and 6.4% in VGT.

The United States shines when it comes to technology, less burdened under government regulation than financials, energy or now health care. Although it has high volatility, technology also has historically high returns. About 20% of the S&P 500 is already in information technology, so our allocation will put 36.2% of your U.S. stock holdings there. For Michael and Jennifer, 2.3% of their total portfolio will be in Apple stock, the highest concentration in their portfolio.

I would use half of the 12 investment options in foreign stocks. Tilting foreign and toward very specific countries may be the best investment advice for 2012. Avoiding countries low in economic freedom and high in debt and deficit may be critical to experience good investment returns.

Last year I included options for ETFs that represented the MSCI EAFE Index of developed countries before recommending specific countries. The EAFE index stands for Europe, Australia and the Far East. Australia is positive, but the Far East is mostly Japan, a country with the highest ratio of debt to gross domestic product. Most of Europe is also firmly in the ring of fire with high debts and deficits. For every dollar invested in the EAFE index, 61 cents is allocated in these countries. Therefore I recommend investing only in specific developed countries.

First I would put 15% of your foreign stocks in these countries high in economic freedom and low in debt and deficit: Hong Kong (EWH), Singapore (EWS), Australia (EWA) and Switzerland (EWL). I would allocate another 10% in Canada (EWC), lower than the others because of its rising debt. These are all ETFs by fund company iShares.

These five countries have the top rankings in the 2012 Heritage Foundation's Index of economic freedom. They all have low debt and deficit. All five countries have better financial investments than the United States. Australia and Canada have better investments for materials. Canada has better energy investments. Switzerland has better consumer staples and health care investments. These countries are the best places where your investments will be free to grow unhindered by the drag of big government.

Finally, I would allocate the last 30% of our couple's foreign stock allocation to Vanguard emerging markets (VWO). Unlike America and Great Britain's century of invention and innovation, emerging countries today can develop quickly.

All Brazil has to do is to send their children to one of our schools for four years. After returning home, they can buy parts for a factory on the global market and be ready to compete with us in a matter of months. All they need is the capital to get started. That's exactly what your investment provides.

Michael and Jennifer would invest 5.4% in EWH, EWS, EWA and EWL. They would invest 3.6% in EWC and 11.0% in VWO, emerging markets that can be extremely volatile but also very profitable.

The last asset class, hard asset stocks, includes companies that own and produce an underlying natural resource. Examples include oil, natural gas, precious metals (particularly gold and silver); base metals such as copper and nickel; real estate investment trusts (REITs); and other resources such as diamonds, coal and lumber.

Do not equate investing in hard asset stocks with investing directly in commodities. Buying gold bullion or a gold futures contract is a direct investment in raw commodities or their volatility. Buying a gold mining company, in contrast, is a hard asset stock investment.

For 60% of your hard asset allocation, we recommend the iShares S&P North American Natural Resources Index ETF (IGE). This index tracks hard asset stocks in North America. It consists of 62% energy and 15% metals and mining. The largest holding in this fund is Exxon Mobil (XOM), the second largest holding in the S&P 500. Given these two ETFs, Michael and Jennifer will have 1.6% of their investments in XOM.

For the other 40% of your hard asset allocation, we recommend the Vanguard Real Estate Investment Trust ETF (VNQ). This fund invests in all aspects of the U.S. real estate market from commercial to residential. REITs are a very small percentage of IGE or the S&P 500. A specific allocation to this sector provides an additional diversified hedge against inflation.

Michael and Jennifer will put 10.2% in IGE and 6.8% in VNQ. These two investments provide an additional allocation to U.S. stocks, tilting the entire portfolio back toward domestic investments. The total tilt will end up 55% U.S. stocks and 45% foreign stocks. Michael and Jennifer's average gross expense ratio would be only 0.31%. (Click to enlarge chart.)

A gone-fishing portfolio is appropriate for limited amounts of money, especially during the accumulation phase. When investors have significant holdings or approach retirement, I recommend seeking professional comprehensive financial planning from a fee-only fiduciary.

May 25, 2012

Much of the quality content here at FMF comes from the comments. There's a lot of wisdom, experience, and good advice on almost every post as readers with some great perspectives leave their thoughts. If you don't read the comments here at FMF, you're missing out!

Every once in a while I select a few that I want to be sure everyone sees for one reason or another -- they offer a helpful tip, raise an interesting point, or so forth. So today I'd like to share three recent comments with you. One is a GREAT tip (and something I'll apply) while two others hit upon things I've been thinking about/seeing in my life or the lives of others.

So let's get started. Here's a comment on my post titled Get Rid of Your Stuff: Make Money, Declutter Your Life, and Help Others. I had noted that every season we go through our closets and pick out the clothes we didn't wear. We then give those away or sell them at a church used clothing sale. Here's how one FMF reader takes this idea to another level:

One thing I learned years ago is that after you purge your closet of clothes you don't wear anymore, to then turn all your hangers around backward on the rod for the clothes you're keeping. After you wear an item, turn the hanger back around the right way. You'll be shocked how many hangers are still backwards at the end of a season - even after you did what you thought was a thorough purge of your clothes at the beginning of a season.

I LOVE this idea -- and we'll be implementing it for sure at our house.

The next comment came when I announced my March Money Madness winner, a post about how a blogger "broke the rules" and bought a new car. One reader responded:

Rules are made to be broken.

Personally I have been looking for a car for my teenage son and I am surprised at the cost of used cars. People and dealers want exorbitant prices which tilt in favor of buying [new]. Until the economy turns around and the demand for used drops I don't see this changing soon.

I am not willing to pay $12k for a 4 year old car with 80k mile on it when I can buy a brand new comparable car for $17k and zero miles on it. (I am talking Saturn Astra to the Chevy Sonic)

The $1250 in depreciation per year is worth the peace of mind over the 4 years, under warranty and you know how the car was driven.

This is exactly the same situation a friend of mine encountered. He wanted to buy his son a used Subaru Forester. But the best ones he could find were vehicles with over 50,000 miles and were only $3,000 less than a brand new one. So, he bought new. I would have too. (Then again, I buy new anyway.) :)

I think the car-buying "rules" are changing. While buying used may still be the better option in the majority of cases, it's no longer a "no brainer" in all of the cases -- and especially with particular models.

Is anyone else experiencing the same thing as you look to buy a new/used car?

I am an advocate of saving and shunning debt but I can't agree that the 401-k millionaires are the winners! Here's why, I recently worked with a friend of mine who retired early at 48; with a million in his 401-k. He had other savings outside his 401-k but not nearly enough to cover day to day expenses etc. So, he ended up dipping into his 401-k-taxed at normal rates with a penalty.

Upon reflection he wishes he had spent more efforts building a million dollar cash portfolio which threw off a lot of income. For those really serious about retiring in their 40's and 50's start thinking about what my friend came up against and maybe structure your portfolios differently.

Exactly. If you plan to retire early and yet have the majority (or even a decent portion) of your retirement savings in 401ks and IRAs, then you better have a GREAT plan on how to live off the non-tax-advantaged savings you do have. Otherwise, you're looking at some big penalties for early withdrawal. Yes, there are ways you can get at the money, but they constrain you at least a bit. Here's what CBS says about what I'd consider to be the best option for doing this (it's one that the majority of people are likely able to at least consider):

Substantially equal payments. If you want to turn your retirement money into an income stream before you're too old, you can do it with the help of what the IRS calls rule 72t. This allows you to dodge the penalty as long you take the money out in "substantially equal" payments over your remaining lifespan or that of you and a beneficiary.

There's even a loophole within this loophole. The payments don't' really have to stretch over your remaining lifespan. You've satisfied the IRS if the payments last five years or until age 59 ½, whichever comes later. After that you can take out as much or as little as you want.

There are a handful of ways your withdrawals can qualify as "substantially equal" in the eyes of the IRS, and they can get complicated. The web abounds with 72t calculators to help you sort things out, but you might want to double check the formula you settle on with a tax adviser.

So there are ways to get at your tax-advantaged money early, but they aren't really great.

I have roughly 60% of my retirement savings in either my current 401k or IRAs that were funded from 401ks at past jobs. So if I ever wanted to retire early, how would I manage doing it without some complicated (and likely expensive) moves (not to mention the lack of flexibility issues.) As a result, my retirement plan schedule by year lists what funds I have access to and what funds I don't in any given year. These numbers give me a really good feel for when I might be able to retire early.

Then I was in the library a few weeks ago looking at the personal finance books and somehow it jumped out at me. I thought "I should read that -- if for no other reason than to let FMF readers know what I think of it." So I checked it out and started reading.

As you might imagine from the title, the book lists nine steps people should take to get a handle on their money. I'm going to give you all nine steps over a series of posts and let you know my thoughts on them.

Step #1 actually has two parts as follows:

Find out how much money you have earned in your lifetime.

Create a balance sheet of your assets and liabilities. What do you have to show for the money you've earned?

I think this is probably the most depressing money-related exercise most people could ever imagine undertaking. This is what it would look like for many Americans:

Look at it this way. You've slaved for 20 years, are halfway to retirement, and what do you have to show for it? $40k. That means, even with growth/appreciation of your savings, you've only been able to squirrel away 5% of what you've earned in your life. And not only that, but it's so small that it's a pittance of what you'll need for retirement, not to mention college and other major expenses. See why it probably seems so depressing for so many?

So why do they ask us to do it? Because it's part of "coming to terms with your past relationship to money." It then sets the stage for "looking at [your] present [relationship with money]." Translation: this shows you how messed up you are because of bad choices in your past. Now we're going to work on setting you straight.

Ok, I can give them a partial break. After all, my first step to great finances is to calculate your net worth. But it's the lifetime earnings that just seems to be over the top for me. It will hit people pretty hard that they have worked so long and so hard for so little. Then again, maybe that's what it's designed to do. :)

So far, I'm not really feeling the inspirational vibe that so many people have noted comes from this book. Then again, I'm only done with step 1. Stay tuned to see if things change for me or not.

May 23, 2012

Taxes! Strong opinions abound on virtually every aspect of the subject—at least among taxpayers. Are taxes already too high, or are even higher taxes necessary to balance the budget? Is the burden fairly distributed, or are adjustments in order? Is the tax code complicated in order to ensure fairness across a wide variety of situations, or is the complication simply the result of privileged interests getting what they want? If you think of those as contemporary questions, they’re really not—they have been brought up and debated for as long as there have been taxes.

If you are interested in pursuing those kinds of discussions, you’ll have no trouble finding forums to do so. But we’re not going to engage in any of that here. Instead we want to take a realistic look at the effect that taxes have on your financial life and offer some practical advice about how to deal with them successfully. In our discussion, we’ll focus solely on the U.S. federal income tax. Even though that’s not the only type of tax that you’ll pay, it is likely to be the biggest, and many of the points that we’ll discuss are adaptable across the tax landscape.

Since taxes are all about rules, that’s the format we’ll take. Below are eight rules that I recommend you follow in dealing with taxes. The first four are principles that you should adopt, and the next four are specific areas of competency that I recommend you develop.

1. Pay your taxes in full, on time, every time. Taxes are serious business, and they deserve your complete attention. A rule like this might seem obvious, but I’m including it to emphasize that taking a casual, haphazard, or last-minute approach toward complying with tax laws is an extraordinarily bad idea. The consequences of ever getting on the wrong side of the IRS, or any other tax enforcement body, are significant.

2. Pay the minimum legal amount of taxes that you owe and not a penny more. Understanding rule #2 requires that you understand the difference between two similar-sounding, but vastly different, words: evading taxes and avoiding taxes. Tax evasion is a criminal offense. It refers to dishonestly or fraudulently misrepresenting your financial status to reduce tax payments. On the other hand, tax avoidance is perfectly legal. This refers to taxpayers making decisions explicitly to take advantage of specific rules in the tax code, to reduce their tax liability. The tax code is complex. Two taxpayers with identical financial situations can end up paying wildly different amounts, both perfectly legally. The taxpayer who pays less has done so by being more familiar with which specific elements of the tax code could be legally used to his or her advantage and then doing so. Legally and financially speaking, there is no virtue at all in paying more taxes than you are required to. Do not evade taxes, but avoid them to the greatest extent that you legally can.

3. Commit to understanding the basics of the income tax and to keeping your understanding current. This rule is a natural extension of rule #2. If you don’t have a good working knowledge of the basics, or at least the basics that are most applicable to your own situation, you are very likely to end up paying more tax than you need to. To state it a little more forcefully—ignorance of the tax code is likely to be an expensive habit. You don’t need to become an expert, and you don’t need to build your knowledge overnight. But you can commit to improving your knowledge of the important basics, year after year.

4. Have an effective record-keeping process. There’s no way around it—a fundamental part of financial responsibility is keeping good financial records. If you’re already following the recommendations made in recent chapters—doing all your spending using either a debit or credit card featuring summarized, downloadable transaction details—then you’ve already got the most challenging part of this under control. Keep this, and all your other financial records, secure (and remotely backed up, if applicable), and your tax preparation process will be significantly simplified.

5. Know your marginal tax rate (your tax bracket) and your average tax rate. You probably know that tax rates are structured in a graduated, or progressive, way. This means that higher and higher levels of income are taxed at higher and higher rates. At the time of this writing, there are six brackets of income, with six progressively higher tax percentages levied on each one. The lowest bracket is 10%, ranging up to the highest rate of 35%. (I’m emphasizing “at the time of this writing” because the number of brackets, and the rates charged, can and do change from year to year. For example, the number of brackets has been as few as three and as many as fifteen. The U.S. Congress has proven very willing to adjust the structure in response to all kinds of economic and political forces and is likely to continue this practice.)

How do these progressive brackets work? Let’s say that you earn just barely enough to put you into the highest tax bracket: 35%. (Congratulations!) That doesn’t mean that your total tax bill is 35% of your income. Instead, you pay 10% on your first “chunk” of income, a higher rate on the next chunk, and so on; you only pay 35% on the very last chunk. In this example, by the time you add all that up, your total tax bill would average out to about 29% of your total income. In tax language, we say that your marginal tax rate is 35%, but your average tax rate is 29%. Both rates are important. The average tax rate is important because it determines your total tax bill. The marginal rate is also important because that’s the rate you’ll pay on any additional income you earn this year. For example, if you are considering earning some supplemental income, understand that you’ll pay 35% on that extra income, not 29%.

6. Have a deduction strategy. Deductions are expenses that the tax code allows you to subtract from your income before your tax is figured. Examples of deductible expenses are mortgage interest paid on an owner-occupied house, charitable donations, a certain portion of your medical expenses, and a long list of others. The more deductions you have (in dollars), the lower your total tax bill is. The tax code gives you a choice: you can list all your deductions one by one and add them up (this is called itemizing) or you can take a single flat amount that the government offers everyone called the standard deduction—one or the other, but not both. Which do you take? Whichever is higher, because that’s how you legally pay the least tax.

It is in your interest to know whether your deductible expenses in any given year are likely to be higher or lower than the standard deduction. Early in your financial life, before you own a house, it isn’t unusual simply to take the standard deduction. But eventually your deductible expenses will probably begin to approach the standard deduction amount, and sooner or later it will make more sense to itemize. You don’t want to miss that crossover point because each year you take the standard deduction when you could have itemized could cost you in unnecessary taxes.

7. Have a withholding strategy. Like most U.S. employees past and present, I am a veteran of many coffee-break debates about what the ideal tax-withholding strategy is. What is a withholding strategy? As Bobby Budget explained to Billy Bigshot, employees fill out a form with their employer called a W-4. Based on how it is filled out, the employer knows how much to withhold from your earnings toward your income tax. When you eventually file your return, if the amount withheld is greater than your actual tax bill, you get a refund check from the U.S. government. If your tax bill is higher than what has been withheld, you pay the government the difference.

Contrary to what a lot of the coffee-break debaters believe, getting a big refund check year after year is not an indication of financial genius—just the opposite! When you get a big refund check, it just means that the IRS has been holding your money on your behalf; and while they are holding it, they are earning interest on that refund money—and you’re not! In other words, you’ve just generously provided the IRS with an interest-free loan. On the other hand, if your employer doesn’t withhold enough, you get to earn interest on that difference, until you have to pay. In both cases, the amount of tax paid is identical—the only difference is who is earning interest.

So what is the ideal withholding strategy? It depends on your skill level at budgeting and tax bill estimation. If you are a rookie at both, then you should be conservative and aim for a zero difference between your tax bill and the amount withheld (zero refund, zero additional tax owed). Once your skill level is high, though, you can get more aggressive at reducing your withholding and earning interest on the money that you will eventually have to pay in taxes. The extra skill is required because you will have to be completely certain that when your tax bill is due, you will have the funds available to pay your taxes. How do you adjust your withholding? Work with your employer’s payroll department, or any tax professional, who can advise you on perfectly legal ways to adjust your W-4 to your advantage.

8. Know when to seek outside expertise, and what kind. Here is a simple model, listed in the order of increasing expense to you:

Level 1: Do all taxes and tax research yourself, using readily available resources. You can buy or check out one or more books, search online, and so on.

Level 2: Use tax software, carefully researching which product best meets your needs and ensuring you only use the most up-to-date version. Often it is possible to use software that can also be used in automating your budgeting process.

Level 3: Engage a certified tax professional. Services can range from simply filing your return based on information that you provide to extensive consultation on tax planning for the current and future years.

When you are just starting out in your financial life, level 1 may be perfectly sufficient. Or you may be someone who is so comfortable with computing tools that you couldn’t imagine filling out a tax form when you know there are simple applications available that can do the job better than you can; if that’s the case, you might skip directly to level 2. Eventually, though, your financial life may get complicated enough that you’ll want to go to level 3. Each level costs more than the preceding one; but each level also offers a greater chance of spotting potential tax savings. The more complex your situation becomes, the more likely it is that it makes sense to move to the next higher level.

You've probably heard it said that during retirement you'll need roughly 80% of your pre-retirement income. This line of thinking has two inherent assumptions:

1. What you make while you work is fairly close to what you need/spend.

2. There will be certain expenses you have now that will go away during retirement. (Yes, some expenses -- like healthcare -- will go up, but overall you'll see a 20% drop in costs.)

For most people, assumption #1 is likely correct. But if you've built a big gap between what you make and what you spend, then this rule-of-thumb is going to estimate your retirement needs too high. For example, consider the following scenario:

Pre-retirement income: $100,000

Pre-retirement spending: $50,000

Estimated retirement income needed based on "80% rule": $80,000

Actual retirement income needed based on spending habits: Something below $50,000 (we'll get to this in a minute)

Difference between actual and estimated needs: At least $30,000

If you think you need $30k more per year than what you actually need, you're going to make incorrect decisions based on this perception (the biggest of which are that you'll likely save too much for retirement and delay retiring for much longer than needed.) This is why I prefer that you actually run the numbers and estimate your actual retirement costs. Then you'll have a much better feeling for the costs you will actually incur while retired and you can plan accordingly. This is what I've done. And I update my spending calculations every other year just to make sure they are still on target.

My biggest expenses currently (if you include saving for retirement and other large expenditures as "expenses" are):

Savings

Taxes

Giving

Family costs -- food, clothing, shelter, etc.

ALL of these should go down significantly (or be eliminated completely) in retirement. Of course I've already taken that into account when I estimated my retirement expenses. However, most people probably don't think about these "savings", and you can see how costs for many will dramatically drop in retirement.

One thing they don't mention is housing costs. I know we've discussed this several times here on FMF, but IMO by the time you retire you shouldn't have a mortgage either. And that simple fact will decrease costs in retirement by 25% or so by itself. Of course if you're reading and following along with my tips, you will be out of debt completely well before you retire. :)

How about you? If you're retired, did you see your costs drop once you quit working? By what percentage? And for those of you planning for retirement, how do you account for potential costs?

Once you are published in a prestige journal you are no longer just one of the more than 200,000 registered representatives in America. No longer are you just Roger or Bill or Barbara. You are now Roger, the writer. One of the great advantages of being a writer is that more and more prospective clients will take the initiative of calling you instead of the other way around. Writers tend to be viewed as experts, and by definition experts have high credibility.

Mr. Balser's article is indeed an implied endorsement from Medical Economics. Endorsements from highly credible, prestigious third parties can make one's career. In my career, I have conducted research for more than half of the top 50 financial institutions in America. Yet I never initially made contact with them. As a professor, to get promoted and obtain tenure, one had to write a lot, and I did. Prospective clients called me and asked me to do research. Eventually I turned much of this research into more articles and a series of books.

Is it difficult to get published? As discussed in my first book, Marketing to the Affluent, it depends upon which of the more than 10,000 trade and professional journals, including newsletters, you target.

I love this idea! It's a way an employee can show expertise, credibility, and influence -- three things that employers LOVE. And when employers love something about an employee it tends to help out that employee's bottom line significantly. ;-)

I've previously shared how I turned my hobby of writing into an income. It started with a chance request where I was asked to write my thoughts on our industry for a top trade magazine. When I found out they actually paid for it, I wrote business pieces for two different trade publications (I actually had a monthly column in one) for several years as well as expanded my writing to personal finances in other periodicals. I made a very nice side income those years doing something I enjoyed.

But what I haven't shared is the impact writing those pieces had on my career. Because I was writing for trusted industry publications and did a decent job with my pieces, I was viewed as an industry expert. As a result, I was invited to speak at industry events. I was asked to visit many of our customers and they sought my advice. I was invited to sit on several industry committees where I networked with even more of our customers. And the more I wrote, the more these opportunities presented themselves.

The climax of these events was when I was given an award (at the annual convention) for the person who most impacted the industry in a given year (note: this was not an award I applied for, like I suggested we all do in trying to get a career award, but one I was selected for.) In addition, my company was named the industry's "Supplier of the Year" two years in a row -- the first time our company had received this award ONCE, not to mention twice. Getting the company award was not only because of my efforts (there were other factors, of course), but it was certainly part of the equation.

The writing benefited my career and compensation as well. A couple years into this process, I actually had part of my bonus tied to writing a certain number of industry trade articles. So I not only got paid from the publications for writing the pieces, but also received a nice bonus once I reached the required number of articles. In addition, I was ultimately hired for a higher-level (and better paying) position by our top customer and ended up working for them for five years. Overall, writing articles for trade publications was a win all the way around.

But it wasn't easy. I had to network to get them to take the initial articles. I had to write most of the pieces on my own time -- at nights or on the weekends. And I had to continually have interesting ideas/topics that the readers would enjoy/use -- otherwise they would stop reading. And I was ALWAYS on a deadline. So don't get me wrong, it was a lot of hard work. But was it worth the effort? It sure was!

I know that this idea is not for everyone. Not everyone is a writer. Not everyone has trade publications they can write for. Not everyone works in a field where others are seeking advice (I wrote on marketing, which was highly sought after advice, but "accounting" might not have had the same appeal.)

But for those who do like to write, have an area of expertise where people want ideas, have trade journals that cover those ideas, and are willing to do the extra work required, writing articles is a GREAT way to both earn and extra income as well as grow your career as an industry expert.

Get ready: here comes one of the most important recommendations in the whole book. It is a trick that makes your left brain happy by getting the power of compounding working in your favor but slips right by your right brain’s bag of tricks. This recommendation guarantees that you will follow the First Rule, month after month and year after year.

It is called Pay Yourself First.

Here’s how it works: the First Rule requires that you save 10%—minimum—of everything that you ever earn. So first you decide what percentage you are going to save and then convert that into a dollar amount. Next, make that amount the very first line item in your monthly budget. Think of this savings as a bill that comes to you every month—a completely nonoptional bill that you can’t ignore or delay. Then as soon as the month begins, pay that “bill” first, before you spend any other money whatsoever. The way that you pay the bill is by transferring that amount from your checking account into your savings account. It’s like saying “I know I have to pay my landlord, the electric bill, my phone bill, etc., every month, and of course I will. But I am going to pay myself first.”

This changes your mentality about spending and saving in a subtle but extremely powerful way: you no longer save what is left after spending. Instead you spend what is left after saving. The difference may sound subtle, but its power is profound.

It works even better if you can make it automatic, which I highly recommend. Do this by preauthorizing an automatic monthly transfer, from checking to savings, in the amount that satisfies the First Rule (at least), on the same day that your paycheck is deposited. Your right brain’s preference for the path of least resistance usually hurts you financially, but paying yourself first turns the tables and allows you to use this tendency to powerfully help you instead. The money is out of your account (and your mind!) before you even realize that it was ever there. You’ll never miss it, so it won’t feel like a sacrifice. You’ll be consistently doing the right thing financially, in such a way that it doesn’t hurt a bit. In fact, after you set it up, you won’t even notice that it’s happening. The only time that you’ll notice it at all is when you happen to notice your savings account balance and are surprised by how big it is getting.

By the way, paying yourself first isn’t a secret, and it isn’t new—it’s been around for generations. It’s so well known for its rock-solid effectiveness that it’s the primary technique used by the U.S. government for its own revenue collection. When you get a paycheck from your employer, you’ll notice that an estimated amount for U.S. income tax has already been taken out before you get your hands on your pay. If the IRS doesn’t want to take the chance that it won’t get paid, why should you? Paying yourself first takes the chance out of increasing your net worth and makes it a sure thing. It’s like money in the bank. Wait . . . it is money in the bank!

Getting the Most for Your Money

So far, all of our emphasis in this chapter has been on keeping your total amount of monthly spending under control by using the budgeting process. As long as you do that, you’ll be following the First Rule and your net worth will grow. In addition, the learn step in the budget process will increase your spending skills, and this is important. Two people can spend the same amount of money in a month, but the one with the superior spending skills will be able to afford more (or better) goods and services for the same amount spent. Alternatively, two people can buy an identical set of goods and services in a month, but the one with superior spending skills will buy them for less, and therefore will be able to save faster.

People who have mastered the art of spending waste less money and get more for the money that they do spend. You’ll learn how to do this yourself as you continue to repeat the learn step in the budget process, but I’d like to give you a head start by outlining some of the key elements of spending skills. Here are seven of them.

1. Don’t make individual yes/no decisions—prioritize. The most basic level of prioritization is separating needs from wants. There is no debate that you need a basic level of food, clothing, shelter, and health care. But everything beyond that is a want. What prioritization is all about is ensuring that your needs are paid for before any wants and deciding which of your wants you want the most. Because you are committed to staying within a fixed amount of spending each month, every time you say yes to a want, you’re saying no to other ones. Your goal at the end of the month is to look back and be satisfied that you got the most for your money—that you spent it only on your needs and your very highest-priority wants.

The worst possible way to get that result is to make your spending decisions one at a time, as they come up or as they occur to you, as if every spending decision were completely independent of every other one. Decisions will come at you at disjointed, random times—so you’ll get disjointed, random results. Without prioritization you just spend your way through the month, saying yes when it seems like a good idea, and you run the risk of spending your monthly total before the month is over. (The technical phrase for this is “running out of money before you run out of month.”) The only possible way to end up close to a good prioritization is to look at all of your possible spending alternatives together, at the same time, so that you can compare them against one another. The wrong question to ask is “Should I buy X, yes or no?” The right question to ask is “I can afford to buy X, Y, or Z, but only one of the three. Which one of them makes the most sense for me right now?”

The budget process forces you to prioritize your spending in just this way, in advance. This kind of “advance comparative thinking” will become a habit and will give you a much higher level of satisfaction with your spending decisions than the “serial yes/no” approach. You’ll become much less tempted to make spontaneous exceptions to your budget, because you’ll know from your own experience that you’ll have to pay for them by doing without something else that you wanted even more.

2. Be a smart, well-informed consumer. We’re all bombarded by advertising around the clock. This virtually guarantees that we get a constant, unrelenting view of exactly one side of the story. Everybody knows what this side of the story looks like: the benefits of buying are mind-bogglingly wonderful, the price is unbelievably low, you’ll be admired by everyone you know, and unless you act now, you’ll really be missing out. Is that all you need to know, or is there another side to the story?

Of course there is—but you’ll have to do some of your own homework in order to get it. If you put some effort into this kind of homework, I’ll promise this: you’ll be amazed by how much you can save, easily. Become familiar with consumer-oriented publications and forums. Check out user reviews on the Internet. Get educated about the real trade-offs between new vs. used, and about branded vs. not. Ask friends or colleagues who have made similar purchases what they learned in the process. Spend a few minutes looking at coupons in the mail before throwing them out as junk. Learn which things you should never pay the full asking price for. Understand why Homer Simpson says, “Extended warranty? How can I lose?” If you’ve never done this kind of research before, it might sound like a lot of work. But like many other areas that we’ve been talking about, the key is to establish a habit. There is no real shortcut to becoming a smart, well- informed consumer. It takes a commitment to doing the homework, but the payoff for doing so begins early and is well worth it.

3. Smooth out nonrecurring expenses. Most of the expenses in your budget come to you in relatively predictable monthly amounts. But some of your expenses won’t follow this kind of monthly pattern. You might have some that are once a year, like membership fees, holiday gifts, or annual vacations. Others might be one-time expenses, like purchasing a major appliance, a new computer, or a training course.

This is where your emerging habit of long-term thinking can come into play to improve your financial life. The idea is to begin planning for these expenses early, well before you need the money to pay for them. How do you do that? By including them in your budget, in small, regular monthly amounts. Similar to paying yourself first, you simply transfer these amounts to savings each month, where they’ll earn interest in the meantime.

Financially speaking, not every month is the same. But the trick is to use your budget to make every month seem roughly the same. When it’s time to pay the nonrecurring expense, since you’ve saved for it in advance, your monthly process won’t skip a beat. For those without budgets—or who don’t use their budgets to anticipate these kinds of expenses—financial life can be a chaotic series of up- and-down months. Smoothing out your nonrecurring but perfectly predictable expenses frees you up from all of this unnecessary stress. This feeling of being in control of your monthly expenses is one of the more immediate benefits of budgeting; you’ll be surprised by how easy it is once you’ve gotten the hang of it.

4. Plan for unplanned expenses. Your car needs new brakes much sooner than expected, your doctor prescribes some new and expensive medication, or your microwave blows up and needs to be replaced. All kinds of things like this invariably pop up, and the one thing that they have in common is that they weren’t in the budget. We’re not talking about huge financial emergencies here—we’ll cover those in a later chapter. Instead we’re talking about those bothersome, unplanned expenses just big enough to put a painful dent in this month’s budget. That means that you’ll have to scramble to find the money by doing without some other things that you’d been planning on. Unless, that is, you’ve taken some precautions.

Look at it this way. Even though events like these are rarely planned, what is the probability that your car will never need an unexpected repair, that you’ll never get sick, or that a household appliance will never need replacing? What to do? Build a contingency fund into your budget, that’s what.

Let’s say that your goal is to do a little better than the First Rule minimum, and you intend to save 15% of everything you ever earn. The way that you plan for unplanned expenses is to put a line item in your budget called “contingency fund.” If you budget for 3% of your earnings on that line, all of your other—planned—spending will be set as if you were planning on saving 18%. The difference between the 15% and the 18% is a pool of excess savings that you can draw on when these unplanned expenses occur. At the end of the year, if it turned out that you needed the 3%, you’ve got it—and you still achieved your goal of saving 15%. If it turned out that you didn’t need the 3%, then you’ve saved more than you planned and your net worth is increasing faster than you’d planned—oh, darn!

5. Avoid using currency. There are many forms of what economists call cash and cash equivalents—we’ll learn more about them in upcoming chapters. But probably the most familiar of all the forms of cash is currency—coins and bills—whether in your pocket, purse, wallet, piggy bank, or between the cushions on your couch. Do you understand now what I mean by currency? Good. Now, stop using it.

When you spend coins and bills, they leave no trail. Unless you want to collect paper receipts all month, or keep some kind of transaction-by-transaction record, using currency short-circuits the compare and learn steps in the budget process. It’s like mystery spending—who knows where, when, or how it was used? All you know is that it’s gone.

When you spend with a debit card, a credit card, or by check, you leave a specific record of what the purchase was for, which greatly facilitates the budgeting process. The best approach of all is to select just one of those three (debit card, credit card, or check), and use that for every transaction. (We’ll cover which one of the three is best a few chapters from now.) That way, the results for the entire month are available online, all in one convenient place, in downloadable form. This makes the compare step a snap, and you can spend more time in the learn step.

Yes, there are exceptions. It may not work particularly well to pass your debit card down the aisle at a baseball game to a hot dog vendor or to write a check at an automated turnpike toll booth. But the more you can avoid using currency, the smoother your budget cycle will be.

6. Small transactions repeated a large number of times add up. Sounds obvious, doesn’t it? But this is one of the most common spending traps that those who don’t budget fall into. Why go to the trouble of bringing your lunch to work? It’s always easier to go out; bringing your lunch might only save $5 or $10. The key is to understand that it is not a $5 or $10 decision—multiplied by 200 lunches a year, it is a $1,000 or $2,000 annual habit. Maybe those lunches are worth that much to you, or maybe they’re not, but the point is to make the decision consciously, prioritizing the lunches against other things that you could spend that same amount of money on.

Budgeting forces you to look at the small-dollar, high-volume transactions and see them realistically. Operating without a budget, or letting these kinds of expenses escape scrutiny by using currency to pay for them, will allow you to be lulled into thinking they’re much smaller than they really are.

7. Beware of the subscription effect. Many service providers charge for their services on a regular monthly basis. Often it is convenient for both you and the service provider to set up an automated payment scheme, which calls for you to preauthorize payment from either your bank account or a credit card. Examples include services like cell phones, cable or satellite television, club memberships, and insurance coverage. If you are completely certain that the monthly amounts will never change and that the duration of the agreement cannot be extended without your explicit permission, then you are on safe ground. But if the monthly charges are subject to variation, or if the agreement can be automatically extended or renewed automatically, then watch out! This situation leaves you vulnerable to what is sometimes called the subscription effect, and it is financially dangerous; you might end up paying much more, and/or for a longer period of time, than what you had originally preauthorized. Here’s how it works.

It starts with highly visible advertising for a very low monthly rate for a certain set of services. (The rates are often especially low if you are switching over from a competitor.) These low rates are only temporary, but you will only find that out in the fine print. These temporary low rates are called teaser rates. Before long, the teaser rates go up—sometimes very substantially. The seller heavily encourages you to preauthorize an automatic monthly payment, allegedly for your convenience. But the seller’s real motivation is to encourage an “out of sight, out of mind” situation so that you (hopefully) won’t notice when the teaser rates expire and the higher rate takes effect. After several more months, the seller may implement yet another price increase. If you’re notified at all, the communication is usually in the tiniest print available and specifically designed to encourage you to ignore it. A similar tactic may be used when it’s time to renew your agreement; it isn’t uncommon for service providers to automatically assume that you want to renew unless you specifically notify them to the contrary.

Here’s another twist. Let’s say that the seller has three levels of service: red, white, or blue. You sign up for blue. A year or so later, the seller redesigns all their service packages and now has four levels: bronze, silver, gold, and platinum. The seller notifies you of this exciting new development and advises you that “gold” is the closest to what your current “blue” service level is. So, supposedly for your convenience, they offer to make the assumption that your choice is to switch to gold, and if you agree, you don’t have to do anything—they’ll take care of everything automatically! Well, gold may be the closest to blue, but it is a safe bet that gold has a higher price than blue. Unless you are the type to read every line of fine print in what looks like a routine piece of mail, you’ve just “agreed” to pay a higher price—by doing nothing. Suffice it to say that these sellers know all about the paths of least resistance. The idea is that they’ve got a little hidden drain in your financial bathtub, and they want to steadily open that drain up as wide as possible without your noticing a thing.

Your budget process stops this tactic cold. They’re hoping you won’t notice the steady increases, but your budget forces you to notice every increase. Each increase is a trigger for you to reprioritize the spending against all of your other spending and make conscious decisions about whether to accept the increase, downgrade your service level, or cancel it altogether. If it sounds like I’m making a big deal out of one small part of your spending, wait until you set up your first budget. If you’re like most people, you will be surprised by the large percentage of your total spending in the automatic monthly billing category. It is a big deal!

Decision Time

Earlier in this chapter, I noted that many people choose not to adopt a budget process at all because it doesn’t seem like much fun. And even though I’ve done my best to convince you, point by point, of the many advantages of a basic budget process, I’m sure that some of you still aren’t ready to commit to it. I won’t sugarcoat it; even though the budget process eventually becomes a breeze, the first few cycles are likely to be time consuming and maybe a little bit frustrating. That’s because you’re learning lots of very valuable lessons in a concentrated period of time, and I highly recommend that you begin right away.

But for those of you who just can’t stand the idea, let me offer this alternative. Strictly speaking, you don’t have to use a monthly budget process, but if—and only if—you faithfully follow the First Rule (which, as you’ll remember, precludes any form of borrowing whatsoever) and pay yourself first every month without exception. If you follow these two rules, you can just spend each month until you run out of money—and then stop.

If you choose this alternative, there is good news and bad news. The good news is that your net worth will continuously grow—maybe even as fast as it would if you were doing monthly budgeting. You’ll also be able to use every other tool and recommendation in the book; none of them are dependent on your doing a monthly budget. Now here is the bad news: your financial life will be quite chaotic. Especially when you are in any kind of transition (a move, adding a spouse or partner, new dependents, new job, etc.), you’ll find yourself running out of money before you run out of month and having to scramble. And you definitely won’t get as much for your money as if you’d budgeted. Once you’ve had enough of this bad news, you can always change your mind—when it comes to budgeting, better late than never!

The choice is yours: implement the monthly budget process as was just described, or skip it and instead rely only on the First Rule (which precludes any form of borrowing) and Pay Yourself First shortcut.

Before you decide, consider this: would you invest in a company that doesn’t budget, when there is overwhelming evidence that most successful companies do? Isn’t investing in your own financial future at least as important?

May 20, 2012

This recent Wall Street Journal article talks about how some people deal with their religious beliefs in estate planning. It spends most of its time on how people disinherit some relatives that don't follow in a specific religious path (like marrying within the faith), but I'm going to focus on another issue related to estate planning and religion -- leaving part of your estate to your church (or, for that matter, to any charitable organization.)

There seems to be two primary thoughts on giving money (for those who want to give) as follows:

Give while you're alive out of your income.

Save and invest as much as you can while you're alive. Then, when you pass away, a good amount is given to your favorite charity.

We prefer the first option as our primary means of giving. We like knowing where our money is going and how it's being used, and it's difficult to do that once you're dead (though there are ways you can direct it with at least some certainty.) That said, we do have a provision in our wills that once our kids are cared for financially, the rest will be given away to various charities.

This implies that we have a set amount that we want to leave our kids, which is true. We want to leave them enough to both complete their education as well as get a good financial head start on their lives, but we don't want to have them swimming in wealth -- so much money that it's a detriment to them. Of course, this is a tricky thing to try and project -- just how much is "enough" but not "too much"? So we've probably erred a bit on the "too much" side. Even then, we'll have plenty left over to go to various charities.

How about you? Does your will leave money to your church or favorite charity?

May 19, 2012

In the last several columns, I have described the investment science that supports dynamic asset allocation. Think of static asset allocation as where to set your sails and dynamic asset allocation as a way to keep your balance as your boat glides and sometimes bounces through the waves.

A static asset allocation, not the same as a buy-and-hold strategy, already has a dynamic component. Buy and hold sets an asset allocation and then allows the portfolio to drift. The portfolio generally moves in a more aggressive direction, increasingly overweighting whatever has done well. It's certainly a better strategy than jumping out of the markets after a drop and waiting to jump back in after a rally. But it isn't the optimum strategy.

Asset allocation is a buy-and-rebalance strategy. Portfolio rebalancing boosts returns. And thanks to a rebalancing bonus, this strategy produces portfolios with either higher returns or lower volatility. By looking at the mean return and standard deviation of an asset class, you can gauge its distance from the efficient frontier. The correlation of an asset class to other asset categories determines the optimum ratios of those two indexes in your portfolio.

We used a ratio of excess return to standard deviation called the Sharpe ratio to measure the efficiency of each asset category. Then we used a proportionally weighted allocation based on the square of each Sharpe ratio to create a portfolio asset allocation. I humbly call this the Marotta allocation method.

Previously we've looked at the Shiller price-to-earnings (P/E) ratio. We took the current price and divided by the average inflation-adjusted earnings from the previous 10 years. This measurement is also known as the cyclically adjusted P/E ratio, or the Cape ratio, abbreviated as P/E 10.

The Shiller P/E ratio helps determine the expected forward-looking return of an investment or index, not if you should be in or out of the markets. Another measurement is the forward-looking P/E ratio. It uses projected earnings for the next 12 months.

The projected P/E ratio can help us decide where to invest. If one index's projected P/E ratio implies it is relatively cheap and another that it is relatively expensive, overweighting the inexpensive index should boost investment returns.

For example, take the projected P/E for the Russell 2000 small cap divided by the projected P/E ratio for the Russell 1000 large cap. This ratio of P/E ratios averages about 1.033. Small cap has a slightly higher P/E ratio because people are willing to pay a little more for a small-cap stock. Although the mean ratio of P/E ratios is close to 1, the standard deviation is 0.122. One standard deviation is a good measurement to use. When the ratio is as high as 1.155, the market is signaling that small cap is relatively expensive and large cap relatively cheap. An allocation tilted more toward large cap should do better. And when the ratio is as low as 0.911, one standard deviation, the market is signaling that small cap is relatively cheap and should outperform in the coming months. Tilting dynamically between asset categories can boost returns even more than asset allocation.

Let's look at four concrete examples for the U.S. stock allocation of our gone-fishing portfolio. Our first two examples represent the extreme indexes of large-cap and small-cap value. First we put everything in the S&P 500. Then we put everything in the Russell 2000 Value. Our third asset allocation is a static one with two thirds in the S&P 500 and one third in the Russell 2000 Value. Normally an allocation that tilts toward small and value will have higher returns. (click chart to enlarge)

The final asset allocation is done dynamically. One third is put into the S&P 500. The remaining two thirds is divided between the S&P 500 and the Russell 2000 Value. Normally the allocation is split evenly. This results in the same allocation as the static asset allocation with two thirds in the S&P 500 and one third in the Russell 2000 Value. This normal allocation occurs when the ratio of the projected P/E ratios is at the mean of 1.033.

But as the ratio of the Russell 2000 projected P/E to the Russell 1000 projected P/E rises, this dynamic allocation will tilt more toward the cheaper large cap. At 1.155, one standard deviation higher, the dynamic allocation will be all toward the S&P 500. And as the ratio drops to 0.911, one standard deviation lower, it will approach the dynamic allocation being entirely in the Russell 2000 Value. Because one third is always in the S&P 500, this results in two thirds in the Russell 2000 Value.

We looked at the mean monthly return and standard deviation of these four portfolios from 1979 through 2011. The S&P 500's monthly return was 0.97% versus the Russell 2000 Value's 1.13%. Annualized, that's the difference between 12.33% and 14.45%. (click chart to enlarge)

The Static 2:1 asset allocation boosts returns by approximately the one-third higher returns of the Russell 2000 Value allocation. The only benefit of asset allocation is that this 0.70% annualized higher return (13.03%) could be gained without any additional increase in standard deviation.

Amazingly, over this time period the dynamic allocation boosts returns another 1.19% over the static allocation, even though the average asset allocation was no different. The dynamic asset allocation has an annualized return of 14.22%, although the monthly standard deviation was no more than the S&P 500. (click chart to enlarge)

Boosting annualized returns by static and then dynamic asset allocation 1.89% without adding monthly standard deviation, you can reap the benefit of careful portfolio construction and dynamic changes based on the ratio of projected P/E ratios. (click chart to enlarge)

We've been using the U.S. stock portion of our portfolio to illustrate how static portfolio construction using the Marotta allocation method gives us a starting target. Then a ratio of projected P/E ratios can be added to offer a dynamic component and boost returns even more. In our typical portfolios, the percentage allocated to a U.S. style box is usually less than a quarter of the total portfolio. But this same methodology can be used with any noncorrelated asset categories to provide a dynamic allocation model.

My parents certainly didn't provide economic outpatient care -- they didn't have anything to provide. It will be interesting to see what we'll do for our kids as they get older. Will we be able to resist helping them financially (more than appropriate) when/if they need it?

I don't think I'm proficient in targeting market opportunities (for instance, to develop a business of my own), but I certainly did choose the right occupation. Specifically, getting an MBA has been a goldmine for me!

After The Millionaire Next Door, Dr. Stanley wrote The Millionaire Mind. This book went a step further into (as you might imagine) the mindsets of millionaires and attempted to determine the traits they felt had caused them to be wealthy. Dr. Stanley distilled there success to these five things:

It's hard for me to honestly evaluate myself on these five factors, but of the group, there are three that I think have been a major part of my success to date:

Discipline -- I have always been a pretty disciplined person, whether it's in academics, business, or personal habits. I generally use lists and measurement tools to help me achieve many of my goals and keep myself accountable. Others would likely call me anally retentive. :)

Spouse -- As I've noted, my wife plays GREAT defense. She is even more frugal than I am (I know, you probably find that hard to believe, but it's true.) She fits the mold that Dr. Stanley talked about in Stop Acting Rich -- she's not interested in displaying our economic success. This is an awesome characteristic to have in a spouse because without it, you can be sunk. It doesn't matter what one spouse earns, if the other spends that much and more, the family's finances are doomed.

Hard work -- I have always succeeded by hard work, not raw ability. For example, my intelligence is (IMO) a bit above average at best (even though I always tested well and was at the top of my class.) But my "secret weapon", what set me apart academically, was the fact that I was willing to work harder than almost anyone. I was willing to spend three hours (or more) studying every night of college when most others weren't. Then in grad school I was willing to spend five hours (or more) studying every night when most others weren't. In my career I've been willing to put in the extra hours and work as hard as needed to do a good job. And all that effort has paid off quite nicely.

I realize this can sound like bragging, and I really don't mean it that way. Believe me, I have a whole laundry list of stuff I could do better in all areas of my life. But fortunately Dr. Stanley doesn't have that list for me to comment on. :) Anyway, I'm simply trying to reinforce the fact that much of what he's said in his book has held true in my life. I'm sure there are others of you out there that have had similar experiences.

So what's your take on this information? Does it fit with what you've seen in life yourself or is there something missing? Give us your thoughts in the comments below.

May 17, 2012

A common measurement given on financial sites for a stock, index or fund is the price-to-earnings ratio, or P/E ratio.

The P/E ratio is the market price per share divided by the annual earnings per share. For example, if a stock is trading at $15 per share and the company has earnings of $1 per share, the stock would have a P/E ratio of 15. If you bought a share for $15, during the next 15 years you would get your money back in earnings and still own the share of stock.

Although the P/E ratio of the S&P 500 varies widely over time, it averages about 15. Getting $1 for every $15 you have invested equals a return of around 6.67%. This is about the average return over inflation of the stock market.

Your investment appreciates in two ways. First, the value of the company appreciates by inflation, which generally has averaged about 4.5%. Second, the company has earnings that bring an additional 6.7% return. Sometimes a portion of these earnings is paid out in dividends. Other times the earnings are reinvested to grow the value of the company by opening more stores or buying other companies. Regardless of how the earnings are used, the total return in dollars is around 11.2%, about 6.7% over inflation.

Although both the P and E are defined in "per share" terms, the ratio is often calculated for the company as a whole. Total capitalization is price times the number of outstanding shares. And total earnings is earnings per share times the number of shares. Hence the P/E ratio is the total capitalization of the company divided by its total earnings.

Several different numbers can be called the P/E ratio. For example, the trailing P/E uses the earnings for the most recent 12 months. This is the most common measurement, often abbreviated P/E ttm, which stands for "trailing twelve months."

An alternative measurement excludes some of the onetime accounting measurements such as large write-offs that can cause a reduction in net earnings. But sometimes these write-offs should be factored into a company's profitability.

For companies with accelerating earnings growth, investors are willing to pay a high P/E ratio for the stock because they expect the earnings E to be higher in the future. As a result, another P/E measurement uses forward-looking earnings or estimated earnings based on the consensus of analyst-projected earnings over the next 12 months. But analysts are often wildly more optimistic than justified by subsequent operations.

At its core, all investing is paying for an earnings stream. When U.S. treasuries are paying high interest rates, people are not as willing to put money at risk in the markets for an equivalent return. At this point P/E ratios fall until stocks are attractive enough in their expected return. And when interest rates of treasuries are extremely low, P/E ratios can rise because there is no other investment offering an attractive expected return.

There are problems using any of these P/E measurements. Sometimes during recessions a company's earnings can be zero or negative over several quarters. When the trailing 12 months of earnings approaches zero, the P/E ttm approaches infinity. This divide-by-zero error often happens when the stock is about to recover.

A high P/E ratio is normally a sign that P price has become higher than it should. But using trailing 12 months of earnings masks movements in price within the divide-by-zero error. Investors are smart enough to know that zero earnings accompanied by a modest drop in price makes the stock attractive to buy on the assumption that earnings will recover. A P/E ttm measurement, however, will still look terrible.

The difficulty with the common ways of measuring P/E ratios is that we want to measure past earnings even when earnings virtually disappear for a few quarters. What we would really like to measure are the changes in price P that cause a company with a good long-term track record to look relatively cheap. Economist Robert Shiller created just such a measurement.

The Shiller P/E ratio is computed by taking the current price and dividing by the average inflation-adjusted earnings from the previous 10 years. This measurement is also known as the cyclically adjusted PE ratio (CAPE ratio), or P/E 10.

Using 10 years of earnings allows movements in price to play their important role in market cycles. After price has fallen but before earnings have recovered is the best time to invest. The ttm P/E ratio will still look bad, but the P/E 10 will be signaling a buy. Similarly, when the markets are doing well and the last year of earnings make it look like P/E ttm ratios are attractive, the P/E 10 will be signaling you to consider trimming stocks that now look expensive.

In his book "Irrational Exuberance," Shiller shows that P/E 10 is correlated to the subsequent 20-year annualized return after inflation. A low P/E bodes well for the next 20 years of investing, whereas a higher P/E 10 suggests a lower expected return.

(Click image to enlarge)

But even if the P/E 10 suggests a lower expected return, it is still appropriate to be invested in the markets. Even a lower expected return is usually sufficient to justify staying invested. Jumping in and out of the markets is not a good investment strategy.

Additionally, the expected return is a 20-year expected return. You cannot justify jumping in and out of the markets based on a 20-year expected return. And finally, average P/E ratios drift based on several factors that have not been modeled in a well-defined system or formula.

The P/E 10 can suggest the proximity of specific indexes or investments to the forward-looking efficient frontier. If P/E 10 is relatively low for an index or investment, it suggests it is closer to the efficient frontier and overweighting it may boost returns going forward. But if P/E is at historical highs, underweighting or lightening up on that particular index investment may lower volatility or downside risk. You can also use the relative ratio between two P/E 10 ratios to suggest that one asset class may be overvalued while another may be inexpensive.

The movements suggested by this approach are small and gradual. This is a much different approach than stock picking or market timing. Indexing is based on the idea that fees matter, whereas this strategy is based on the idea that price matters. And when price gets ahead of what is justified by the past 10 years of inflation-adjusted earnings, then perhaps the exuberance is excessive.

It’s not that the unspoken rules of success are any big secret; it’s just that most executives never bother to talk about them or share them in a way that is useful to and doable by others. That’s where this book and the model I have developed come in.

I want to give you big insights that will shape how you think about your work for the rest of your life, and practical ideas for things you can start doing right now that will make a big difference in your success.

In this book I have gathered all the ideas, insights, and necessary actions and provided the context for how it all works together. Success doesn’t come from being good at just one thing. It comes from doing a combination of things on purpose, over time, that all build on each other to create remarkable outcomes. But you have to understand the whole picture to know why each part of it matters.

My approach for success has three parts. I am a pretty plainspoken person, so I call them

DO Better

LOOK Better

CONNECT Better

Big success requires all three—not in isolation or in sequence, but in combination. Missing any one of them is what causes most career stalls or washouts. Without taking some care to make progress on all three, you fall behind—you get stuck.

Here is where you can begin to see why hard work alone doesn’t cut it. The work is only in the DO Better category. If you burn up all your time and energy doing excellent work, you may fail to get recognized (LOOK Better) and fail to build a network of support (CONNECT Better). So your career stalls. You are doing an excellent job of everything that is asked of you but you still get stuck.

Remember, it’s not just about the work.

To add real value to the business, you need to understand what is truly valuable to the business and you need to build a broad network of support so you can deliver significant results in a big and far-reaching enough way.

DO Better

DO Better is about producing exceptional results. DO Better is about working on the right things in the right ways. It’s about rising above the work. DO Better is about freeing yourself from your overwhelming tactical workload and identifying and delivering on the few most critical outcomes—the ones that really count. DO Better is about tuning your job, knowing yourself really well, and putting yourself in situations where you can thrive in your work and accomplish exceptional things. It’s also about how you lead, build trust, delegate, make more time, and build up your energy. Successful people are not burned out and used up. And they are not the ones who were less busy along the way. They deliver remarkable results and leave room to DO even better after that.

LOOK Better

LOOK Better is about standing out. Successful people do their work and produce their results in a way that is meaningful and visible to people that count. They understand which audiences matter most and they communicate with the right people at the right times, in a compelling way.

LOOK Better is about building personal and professional credibility and becoming more relevant with your key stakeholders. People with high credibility get more done because they face fewer obstacles. Successful people are widely known not just for doing their jobs really well, but for the extra value they contribute to the business. They have risen above the work and proven their greater, wider-reaching value to their companies.

CONNECT Better

The most successful people get a lot of help. CONNECT Better is about building a broad base of support for yourself, your team, and your work. As you advance, your focus needs to broaden, not deepen.

Successful people are not isolated in their own world. They build the right networks of mentors, partners, and supporters. They know how to get on “the List” of people who get access to the best opportunities.

It’s not about politics; it’s about effectiveness. Successful people build an “extra team” around them and accomplish big things by working with and through others. The higher you go, the more your value is associated with your network.

It’s Never Too Early to Begin or Too Late to Start

There are no prerequisites, hurdles, or qualifications to using the model. Set your sights on adding more value to the business and start from where you are today.

You Have More Control Than You Think

You need to recognize that it is up to you to make things happen in your career, without counting on standard company and management processes. These days, if anything, the standard company and management processes are set against you!

My approach is all about the things you can control—how to see them and how to act on them. You need to do specific things on purpose in all three areas of DO Better, LOOK Better, and CONNECT Better over time.

For example, working really hard won’t get you anywhere if no one sees what you are doing or if they think it’s irrelevant. Creating a publicity campaign without the results to back it up will backfire. (We all know those people who are managing their publicity instead of doing their jobs, and it’s hard not to wish bad things for them.)

You can’t build a strong network if you are not credible, and you won’t know how to use contributions from your network if you are not focused on doing the most critical few things to move the business forward. It all works together to add value and grow success in your business and career.

The real payoff comes over time—once you feel like you have mastered all three, you set the bar higher—and do them all again. That’s where the “better” comes in.

Personally, I don't have any of these (and never had.) I didn't even know some of them existed! I guess you can insure almost anything, huh?

Then they list one you may or may not want/need: travelers insurance.

This is one we struggled with when we went on our cruise. We had a friend whose mother got very sick just before a cruise and they had to cancel the entire trip. Because they had travelers insurance, they got all their money back (they had to send in a doctor's note to prove she was really sick.) We went back and forth trying to decide whether or not we wanted to buy it. There seemed to be a 50-50 split among those we asked -- half advocated getting it and half didn't. In the end we decided against it and everything worked out fine.

Finally they list the types of insurance most people need as follows:

Medical insurance

Auto insurance

Umbrella insurance

Renters insurance

Ok, I agree with these, but:

What about disability insurance? You have to protect your #1 financial asset -- your ability to earn money -- right?

What about life insurance? Same as point #1 except covering for death instead of disability.

What about homeowner's insurance? Your house is a HUGE asset. You need to cover it. This applies twice as much to people who are building their own homes. Taking out new build insurance is vital, as it is law in the UK that all new builds have this type of cover”

What about long-term-care insurance? Maybe this should be listed in the middle section of "maybe/maybe not"?

I have medical, auto, homeowner's, disability, life (on both me and my wife), and umbrella insurances. How about you? Do you have more, less, or the same?

The oft-quoted rule of thumb is to save three to six months of living expenses in your emergency fund. But many people these days will need nine months to a year of expenses covered just to get by. Consider that the average duration of unemployment is nearly 40 weeks. That means even if you have six months of expenses saved, there's a good chance you'll use it up before landing a new job.

They also quote these startling facts:

According to a 2011 study by Bankrate.com, 46% of Americans haven't saved enough to cover three months of expenses. And only 24% have saved enough to cover six months or more.

Yikes!

And just to show how bad things really are, the post features a chart where people are asked if their credit card debt is greater than the size of their emergency fund. The results:

25% said yes, their credit card debt was greater than their emergency fund savings

16% said they didn't have credit card debt or emergency fund savings

5% didn't know or didn't answer

Several comments from me:

I don't hold to a set level of emergency funds for everyone, but six months is a good general guideline for someone looking for basic guidance. If you want to get more specific, the post Six Levels of Emergency Funds. gives some additional details.

Personally we have about six months of salary saved up which equates to 12 months or so (probably more) of living expenses. It may be a little overkill for us, so I might trim it back a bit.

Looks like only 24% of the people have met the six-month guideline. Said in reverse, 76% of the people don't have enough stocked away in their emergency funds (especially those 46% who have less than three months of expenses saved).

Then there's the 25% of people who have more credit card debt than emergency fund savings. These people are living on top of financial time bombs. At least the 16% who have neither are in better shape than this group because they aren't paying outrageous interest charges on their credit card balances.

I wonder how much of these poor results come from the bad economy. Or would we have seen similar numbers prior to 2008? It's hard to tell, but my guess is that it's a combination of both -- there's a group of people that won't have emergency funds no matter what and there's another group that has had to deplete (or at least lessen) their emergency funds because this economy has caused them to face an emergency (like a job loss.)

A list of brief tips on some of the most common categories of insurance appears below, plus a few important items from the broader field of risk management. These are brief, so think of them as broad guidelines, not ironclad rules. You’ll need to do lots more research on your own. Above all, keep in mind that these comments are specifically intended for a typical person in the 1st third of their financial life. If you’re not in the 1st third—or if you’re not typical when it comes to that subject—then consider the advice with caution.

1. Health insurance. People early in their financial life are famous for letting their right brains have complete and utter control of their health insurance decisions. Why? The choices are complicated, the costs are high, and the prospect of future illness or injury is unpleasant. Right-brain reaction: “I am young and healthy; in fact I’m downright indestructible. I don’t need any health or medical insurance, or else just the bare minimum.” Bad idea! Tell your right brain to have a seat and engage your left brain in truly understanding what your choices are. You are taking a big and unnecessary risk if you don’t. If you want to save on premiums, go with very high deductibles, not with big gaps in coverage. And keep yourself healthy!

2. Homeowner’s and renter’s insurance. Whether you rent or own, you need it. And keep the list of valuables that you’re insuring current; if you don’t, you’re not getting the value for your premiums that you think you are.

3. Car insurance. Car insurance is broken down into several subcategories. Each state requires that you your car in that state. The specific requirements vary from state to state, but the basic idea is that if you cause an accident, you must have insurance to cover people that you injure or cars that you damage. But there is no requirement that forces you to cover injuries to yourself or damage to your own car in an accident that you cause. Here is the point: of course, you will carry whatever types of car insurance your state requires, but it is a big mistake if that’s the only car insurance that you carry. You’ll want yourself and your passengers, as well as your car, to be covered in the event of an accident. You’ll also want your car to be covered if it is damaged in any other way not related to an accident (vandalism, storm damage, hit while parked, etc.). Save money by having high deductibles but not by skipping entire categories of coverage. And of course, drive safely!

4. Life insurance. Life insurance comes in two types: term and permanent. Here’s the recommendation: you want term life insurance, not permanent. Permanent life insurance comes in many varieties; some of the more common types are whole, universal, and variable. But whatever names they go by, all forms of permanent life insurance have a long-term investment aspect. In part IV, we’re going to discuss a completely different—and much superior—long-term investment strategy, so you’re not interested in any of the permanent insurance– related investments.

Even though your choice is term life insurance, you only need it during a very specific time during your financial life. That time begins as soon as you have any financial dependents, so don’t buy any life insurance at all before then. The time for term life insurance ends when your net worth becomes large enough that you can provide for these dependents through the provisions in your will, or as soon as your dependents are no longer dependent on you. As soon as you meet either condition, don’t renew your term life insurance policy when the current term expires.

5. Private mortgage insurance (PMI). If you buy a house, you’ll probably be required to pay for this type of insurance if you pay less than 20% down. This isn’t good news, because even though you pay the premiums, the insurance is for the benefit of your lender, not you. But as you’ll learn in part III, you will pay 20% or more down, so you won’t need PMI.

6. Long-term care (LTC) insurance. This type of insurance is increasingly advertised, so you may be curious about it. But LTC doesn’t make sense to consider in the 1st third of your financial life; you can ignore it at least until your late 40s. (If you are financially responsible for someone who is one or two generations older, though, you may need to investigate it.)

7. Wills. A will isn’t insurance, but you can think of one as part of your overall risk-management strategy. You don’t need a will if you have no dependents or if your net worth is less than $100,000. But as soon as you meet either of these conditions, you do need a will, no matter your age or health. Don’t put it off—it’s a must. Unless your situation is unusually complicated, you can do it yourself inexpensively.

8. Living trusts. These are often brought up along with wills. But it’s unlikely that you’ll need one in the 1st third of your financial life. Living trusts are important once your net worth becomes large (say, over $1 million), or if there is something unusually complex about your assets or about the way you want to distribute them after your death.

9. Living wills. Despite the similarity in names, a living will is completely different from a living trust, or a standard will, but a living will is very important in its own right. A living will allows you to express your wishes in advance, in the event that you become incapacitated and unable to communicate them for yourself. In particular, you can advise health-care professionals whether you do, or don’t, want your life extended through artificial means if your chances for recovery are very limited or none. Yes, it is a grim prospect to think about, and it can evoke very strong feelings all around. But in the absence of a living will, you may be putting your loved ones, and/or the medical professionals caring for you in a very difficult position. Most people haven’t spent much time thinking about this, but when they do, they come to the conclusion that filing a living will is a simple and inexpensive precaution that potentially can save a lot of heartache. The laws concerning living wills vary from state to state. I highly encourage you to at least investigate this in your own state and then decide for yourself.

May 15, 2012

A few months ago I told you that I had hired a new CPA to do my taxes. Now that the tax season is over and the dust has settled, I thought I'd list the pros and cons of working with the new firm. Let's start with the pros:

They were much more involved in tax planning. While I hired them officially in late 2011, I had met with them earlier in the year and they had given me some tax-saving tips. Some I took and some I didn't, but they were pro-active on their advice -- which is something the other firm never was. In addition, the new firm has continued offering suggestions well into 2012.

The process was initially smoother. I was able to drop off my information and meet with the owner personally to go through my records. This is because they are located much closer to my work, so I was able to pop over there during lunch to get things going.

They were cheaper while doing more. The cost was 20% less than the other firm plus the new company included returns (very simple ones) for my kids. So they delivered more work for less cost -- that's what I was looking for!

But there were some cons. For instance:

The process had a few bumps to it. I knew there would be some since this was our first year with them. But they complicated the effort. There wasn't clear communication between the owner (who I had all my previous dealings with) and the person who actually did my taxes. This caused some confusion and re-work on both sides.

There was a big delay. I got them my information in late February and the owner told me they'd have the return done "in a week or so." Three weeks later I got and email saying they were just starting the return. It was finished and approved the first week in April.

Overall, I was happy with their performance and I'm looking forward to next year. I think the process will be better since they will be more familiar with my finances and I'll know what to expect from them. In particular, here's what I plan to do next year to help things go a bit smoother:

I will meet with both the owner and the person doing my taxes when I drop off my information. This way there will be no miscommunication between them (or at least it will be minimized.)

I plan to meet with the owner a couple times during the year to talk about basic tax issues. I'm at the point where there's not much I can do to save on taxes without jumping through hoops, and many of the hoops are not worth jumping through from time and cost perspectives. However, you never know what's looming around the corner, so I'll keep in touch with him just to make sure I'm on top of the situation.

I absolutely hate having a job objective for three main reasons: 1) It serves no purpose. The objective is already understood -- you want this job. You know that and the employer knows that. 2) It takes up prime selling space -- it's often the first thing a reviewer sees. Do you want to waste the valuable few seconds he looks over your resume on an objective? No! You want that time to be selling how great you are. 3) It's about you: your wants and desires. But a job application is not about you (at least about what you want). It's about the employer -- what HE wants. The only concern for you is whether you fit what he wants or not.

The book suggests you find out what skills, knowledge, and experience are needed so you know how to tailor your resume. In general this sounds like a decent suggestion, but I'm not so sure it's really practical or has much use. If you are in one field and looking to stay in that field, it's likely your resume will be the same no matter what position you apply for (mine has been). Now if you're looking to change careers, perhaps you need a bit more tailoring, but for my entire career I've developed and used one standard resume and it's worked quite well.

As for format, I recommend the chronological resume. I would guess (correct me if I'm wrong) that the vast majority of reviewers expect and prefer this format, so why go against the flow and use something else? Do you want the reviewer to spend the six seconds he looks at your resume trying to figure out the format (and, as a result, what the resume is saying)? I thought not.

I agree with their point #4 -- to list past jobs. BTW, they say in the book to list them in chronological order (with the most recent at the top -- some would call this reverse chronological order). Of course. :)

I also agree with the listing of the skills and accomplishments of each job and describing them in action statements (their points #5 and #6). I try to combine skills and accomplishments as much as possible. For instance, "Led multi-function team to deliver 18% costs savings to new product launch." This statement contains both skills (leadership ability as well as great people skills -- you'd have to have the latter to lead a team from different departments to this much success) as well as an accomplishment (you saved the company 18%!) If you can fill your resume with bullet points like this (my last resume had 5 to 7 of these per job), you've got a winning document.

Steps #7 and #8 are formatting/filler steps IMO. Yes, you need to arrange your statements for maximum impact (for each job I've held I list the accomplishment statements in descending order -- from most important to least). And yes, you need to list education and meaningful training experiences. But these will seldom get you hired, so be concise with them.

I am 50/50 on the summary statement. As a reviewer, I personally prefer to get into the resume and develop my own conclusions about the candidate. But there is probably no harm with a short and sweet (a few bullet points at most) summary of your best accomplishments at the top of your resume. If the reviewer sees nothing else, he will get the main points you want to make, and that's about all you can hope for. That said, if I was looking for a job these days, I wouldn't use one.

The best way to "polish and proof" is to send your resume to several people (trusted colleagues work the best IMO) and have them review it. I've both done this for others and had others do it for me and there is ALWAYS something that can be improved upon.

There you have it. Overall, I think the book is "decent" and it's certainly concise, well-formatted, and contains plenty of great examples of resumes (if you overlook the objective statements). Even though I have some disagreements with their recommendations, I would certainly look at it as one of the resources I'd consult if I was looking at writing a new resume. In particular, their section on how to write powerful action statements for your accomplishments is great.

May 14, 2012

I have $21,000 in student loan debt that was consolidated in 2005 and is now sitting at a fixed rate of 1.625% for 20 years (original balance was close to $31,000). The monthly payments equal $170.

My question is, with such a low interest rate, does it make sense for me to try to pay it off early, or should I take the money that would go to pay it off and invest it or otherwise make principal payments on my mortgage? I have no debt other than the student loan and a 30 year fixed mortgage that is at 4%.

This piece from US News got me to thinking of all the times I've had "summer hours" during my career. The piece defines summer hours as some sort of special work arrangement during the summer -- like being able to come in early and leave early too. My current company doesn't have any special summer work offering, but here are ones I've had in other companies over my career:

We got every other Friday off during the summer. That was nice. :)

We got the afternoon off every Friday for the summer. I actually liked this better. It made every Friday special.

We got to dress casually on Friday. This was when we were all dressing up every day. You know, way back in the olden days -- like the late 80's and early 90's. Oh, and "casual" then was dressier than what I wear to work on a daily basis now.

I may be forgetting some, but I think this is a complete list of my "summer hours" options. Needless to say, I really enjoyed having them all and appreciated the casualness and special feeling they brought to the summers.

How about you? Have you ever had summer hours (or do you have them now) where you worked?

Sometimes it may feel like you are jumping through hurdles to land the actual internship and once you start, you lose momentum. This is a once-in-a-lifetime opportunity, and you must constantly ask yourself, “Am I making the most out of this situation?” You want to constantly evaluate and reevaluate your own performance at your internship: “Am I doing the very best I can? What else can I do?” In my experience, this is the difference between an average intern and a stand-out intern. The sections below provide tips to help you stand out. I titled each heading with what the employer should be saying about you (the intern).

“They are always the first to volunteer!”

We know to volunteer for everything. But do you actually follow that rule? At your internship, one student will be the first to volunteer. Make sure that individual is you. This is a quick and easy way to show that you take initiative and don’t rely on others to get things done. It also shows that you don’t mind doing the less glamorous tasks. If you are interning at an interior design firm and want to sit in on a client meeting—that’s super normal. Everyone wants to sit in on a client meeting. However, if you volunteer to set up the meeting space or make copies of the materials the client needs (tasks that aren’t the coolest), that’s what will stand out to the employer.

“They are always alert!”

When the employer calls your name, you should give your undivided attention. Unless you are preoccupied with another assignment, you should go right over to him or her, look alive, friendly, attentive, and even excited—and have a pen and paper with you. To show your dedication, take notes on everything the employer says. Never roll your eyes or look frustrated when an employer asks you to do a task.

“I’ve never seen them just sitting around.”

Find work for yourself. The second you complete a task or have nothing to do, get out of your seat and ask the internship coordinator if he or she needs anything. If that person doesn’t need anything, ask who else in the department needs help. I mentioned this earlier in the networking section. If no one has work for you, read anything you can get your hands on. Every industry has a variety of trade publications associated with it. For example, in publishing, you should be reading Publishers Weekly every week, and you should also sign up for daily industry news emails such as PWDaily, Shelf Awareness, and Publishers Lunch. Take advantage of the resources at your company and build your knowledge of the news and events taking place in your industry of choice.

“When I give them tasks, they take me seriously.”

Any time an employer assigns you work, you take notes, listen to everything he or she has to say, and then ask questions. Take pride in your work and go the extra mile to let the employer know this is a priority for you and something you take very seriously.

“I trust them.”

Trust is a big issue at an internship. As an intern, you handle paperwork and overhear confidential matters. You won’t always be told what is private and what is public information. Just to be safe, keep all of the company information private. Don’t gossip to friends or family about who that company represents, badmouth any clients, or talk about financial information. Every company has some sort of sensitive information associated with it. Keep everything you hear or learn in-house. Once the people in an organization feel they cannot trust you, they will let you go from your internship. Keep in mind that trust isn’t always associated with confidential information or paperwork—it applies to all of your actions.

“They know what they’ve accomplished.”

Write out what you’ve accomplished. Keep track of all of the tasks that you’ve done during your internship. If you communicate with your boss through emails, checking sent emails is a great way to do this. Make a quick list of the majority of tasks you’ve accomplished and next to each, write down the learning objective. In chapter 5, we discussed how every task has a learning objective tied to it. As an example, let’s take a look at my task list from my newspaper internship:

Fact-Checking for Special Issues. Learning Objective(s): cold-calling, communicating with different types of people, the importance of printing accurate information, learning how frequently information changes, how to stay organized when putting in several outgoing calls, phone etiquette

Proofreading. Learning Objective(s): editing experience, strategies for editing, what editors look for during the proofreading process, the value of a proofreader to a writer

Writing for Publication. Learning Objective(s): helping develop writing style, providing constant feedback from editorial team, publishing for one of the first times

Assisting Production Team. Learning Objective(s): understanding value of entire team working together, watching the process from the producer’s and designer’s perspectives, communicating one part of a project to another team involved in the process, relationship management in the workplace, how an entire newspaper is put together on a weekly basis

Going through and actually writing out the learning objectives will help you understand the full benefit of the opportunity. As the internship goes on, you tend to forget the real value of what you’re doing.

Every so often, he raises up a prophet to teach wayward profiteers about the sacrifice he demands.

The piece goes on to basically say two things:

1. The church is a place where people trust each other which makes it prime territory for financial fraudsters to take money from others.

2. How God doesn't want us to be rich -- in fact, just the opposite -- we're called to be poor (he doesn't say this outright, but says everything but this exact statement.)

Does God want anyone to be rich? It's an interesting question, isn't it? Unfortunately, the answer is elusive. Like in many things in Scripture, your point of view is dependent on your interpretation of the Bible.

My personal interpretation may or may not be "right" but I'll give you my thoughts:

1. It's all about balance. The great (IMO) book Money, Possessions, and Eternity makes a great argument that both extremes in Christianity ("God wants all his people to be rich" and "God wants all his people to be poor") are incorrect. It's quite convincing when laying out why a balanced perspective on finances is appropriate.

3. Much of what the Bible says about money deals with the person's attitude. If the person LOVES money, then it's wrong. But if they become wealthy and use money to love (help) others, money can be a blessing for them both.

I know, it's a very simplistic and incomplete assessment of the situation, but it does give the main points of what I believe. And it leaves plenty of room for you to add on and comment as well. So, what's your take on this issue?

May 12, 2012

The following is a guest post from Matthew Malone, a writer for RothIRA.com, a leading retirement and Roth IRA Resource. Matthew is also a contributing writer to CBS SmartPlanet. His work has appeared in The New York Times, Cosmopolitan, Smartmoney.com, Fortune.com, Forbes.com, and other publications.

Saving enough for retirement means making smart financial decisions--and making them all the time. And the best way to maintain your financial health, and to provide for a comfortable retirement, is to know where you spend and why you spend it. Without such insight, you'll likely waste tens of thousands of dollars over a lifetime, money that could otherwise be waiting for you to enjoy when you decide to retire. Here are five easy to generate new savings, without sacrifice.

Use an online savings account for infrequent expenses

We can usually estimate and budget for monthly spending for things like food, electricity and cell phone bills without much hassle. But people often get into trouble when it comes to occasional but unavoidable expenses like a big car repair bill, year-end tax payments or annual subscriptions. That's because we fail to put away money each month to cover those inevitable charges. The best way to do so is to take the time to go through a year of spending (budget sites like mint.com can help) and get an idea of the source and size of your occasional expenses. Once you do that, sign up for an online savings account and pull money from your main back account each month to cover them. Sites like INGDirect allows you to create up to 25 individual savings account, which you can name and earmark for everything from clothing expenses to birthday and holiday gifts.

Buy used

We're often told that buying a used car is among the smartest financial moves you can make. But in the midst of life's everyday hustle, we often forget to apply the same wisdom to smaller purchases like household tools, lawnmowers, bicycles and furniture. If we give up an obsession with the shiny and new, we can save big, with little impact on our lifestyle. Sharpen the blades and buy a few new parts, and that used lawnmower will be good as new. A slipcover can do wonders for an old couch. And all that extra money can help you build up your retirement fund, something that will make you happier than any new rake ever could. Whenever you need to make such a purchase, check out yard sales, craigslist and eBay first.

Stretch to max your match

Many employers offer to match some portion of retirement savings up to a percentage of annual income. For instance, they might match your contributions dollar for dollar up to 6 percent of your salary. At a $50,000 salary, that's $3,000 simply for being a conscientious saver. It's one of the best ways to quickly grow your nest egg. So make sure you stretch to hit the match "threshold." Otherwise, you're leaving free money (and a more comfortable retirement) on the table.

Subscription music

If you buy, on average, one or more CDs or downloaded albums a month, you're a great candidate for a digital music subscription. Services like Rhapsody and Spotify give you unlimited streaming (and in some cases, offline and mobile access) to huge libraries of music. The services cost about $10 a month. While there are some notable omissions from the catalogs (the Beatles, for instance), you probably already own music from your top bands anyhow. And the services allow you to check out new bands and genres of music without paying for a something you might never listen to again. You must, of course, have decent Internet access to make it worthwhile.

Keep texting--the right way

For many, texting has replaced e-mail and even phone calls as the preferred method of mobile communications. The trouble is, most cell carriers charge you $5 or more for a set number of texts (or 25 cents per text without a plan). But several services, most notably Google Voice, give you free unlimited texting to and from a smartphone, and even a home computer. While the services may require you to use a new number for texts, the number can be easily shared with a single e-mail and programmed into your friend's contacts list. At savings ranging from $60 to $240+ a year, it's a no brainer. One word of warning -- some services offer limited support for texts with media attached (photos, audio files or video attached), but those features are likely on the way in the near future.

May 11, 2012

The following is the latest post in my "Reader Profiles" series. Each post in this series details the financial situation and challenges of an FMF reader. The purpose of this series is to help us all identify with people like us (in similar situations -- not all will be, of course, but eventually I'm sure you will find someone like you here), get to know the frequent commenters on the site, and hear some financial wisdom/challenges from people other than me.

If you're interested in contributing to this series, then drop me an email. The series seems to be very popular with readers and I need a steady stream of new ones to keep it going.

Next in the series is FMF reader CW. He answered my questions (in red below) as follows:

Please tell us a bit about yourself.

I came to know about freemoneyfinance blog 3 months ago and I’ve always enjoyed reading the reader profile posts. This is our story.

My wife and I are both 35 years old and have 2 kids (8 and 4 years old). We grew up in Asia and currently live in Southeast region in the US. I have worked for a large IT European company for almost 12 years. During the early days of my career, I was very fortunate to be part of a group which rolled out IT systems to various countries. From 2001 to 2007, I was based in Vienna, Austria but would frequently travel to Asia, Australia, Europe and the US. My overseas assignments would typically be between 3 to 6 months. The company also allowed my family to accompany me during these trips. It was not easy, but it was quite an adventure and we had many wonderful memories. When our eldest child turned 3, (with very strong hints from my wife) we decided that it was time to settle down. In early 2008, an opportunity opened up in the US branch and we have been here ever since.

We always had to rely on 1 income. With our frequent travels and having to take care of 1 young child (our 2nd child was not born yet), it was not realistic for my wife to work. In 2001 to 2007, my annual salary started from €45,000 and eventually increased to €55,000 (~$59,000 to $71,500 based on 1.30 exchange rate). When travelling, I also received extra allowance to cover airfare, accommodation and basic transportation. This arrangement enabled us to save a lot. Our living expense was very low and it discouraged us from buying stuff since we did not know where the next location would be. During this time, I had no concept of financial planning. If we had money in the bank, we spent, if not, we didn’t spend. It was simple as that.

We settled in the US in the early part of 2008. Moving to a new location is costly, even more so if it is a different country. I anticipated big expenses to come, but did not expect for our spending to go out of control so quickly. In the beginning of 2008, we only had 6 suitcases to our possession. In a period of 1 year, we bought a used car ($12,000), a new car ($20,000), and a new house $260,000 (20% down, mortgage for $208,000 30yr@6%). We also probably bought $30,000 of new “stuff” to furnish the house. Although we had no credit card debt, it was clear to me that something had to be done.

Describe your financial situation (who works in your family, how your income is (general), how your expenses are, etc.).

It was in the middle part of 2009 that I started to seriously learn how to manage our personal finances. I started checking out several financial blogs and eventually became a regular reader with getrichslowly, thesimpledollar and recently with freemoneyfiance. We incorporated plenty of ideas into our personal finances. But it was tracking our expenses to the penny via Quicken which helped us the most. It enabled us to see where the money went, helped us adjust/control spending and enabled us to make a more accurate budget.

I currently earn $108,000 per year with the possibility for an extra 10K bonus. My monthly net pay is around $6,000 (less all the deductions such as health, dental, disability insurance, 401k, HSA, etc..). Our budget is based on net pay. Any additional income such as tax refunds, bonuses and cashback are treated small windfalls and goes to savings (or occasional splurge).

Our current monthly budget (family of 4) is as follows:

Auto (2 cars – gas, insurance, maintenance, etc..): $550

Childcare(needs-school fees, supplies, clothing, etc…): $260

Education (for my wife): $500

Groceries (food): $450

Groceries (non-perishable): $85

House (needs - HOA, termite bond, garbage, maintenance, etc…): $350

Mortgage (principal, interest, escrow): $1,620

Utilities (gas, electric, water, phone and internet): $265

TV (Streaming): $20

529: $200

Savings (roth): $200

Savings (non-retirement): $400

Dining out : $200

Home improvement: $200

Vacation: $400

“No questions asked” fund (my wife and I each get $150 per month to spend on anything. No questions or complaints): $300

What are the current financial issues you're facing (saving, paying off debt, etc.)?

The next couple of years will be very tight on our finances. My wife is currently pursuing a 2nd bachelor's degree at a local university. She did not work for almost 10 years. Unfortunately her first bachelor's degree in IT is already obsolete. We’ve decided to invest in her education which would allow her to start a career path in the healthcare industry. Although we do have the savings to fund her education, we want to manage it within the current income. As a consolation, our tax refund for this year was the highest we’ve received, partly because of deductions and credits from my wife’s education.

Another issue is figuring out how much we need for retirement. In fact, we don’t have a retirement plan. Although we are committed to stay here for the next 10 years, I’m not certain where we will be after that. We have talked about going back to Asia to work or even start a business. I find it quite hard to plan for the next 30 years. Plans can change rather quickly. 5 years ago, we planned to migrate to Australia, but ended up here in the US.

What are your plans for the future. (retire early, build your career, etc.)?

I will continue to track our expenses via Quicken, but will use the data to look at the “big” picture. I’ve used the data to create a “Balance Money Formula” report from GRS, analyzed trends in our expenses and created a better budget tracking.

I dream of the day where I pay-off the mortgage, fully fund our children’s college fund and am able to travel more. For now, I’m putting more effort to develop a 2nd (or more) income stream. My wife’s education is part of the plan, but that is still a couple of years from now. We’ve also looked at blogging as a possible option and also developing our hobbies as a side business. We already have plenty of ideas, and it just a matter of finding the time to focus and implement it.

“Spend less than you earn.” Very simple, yet very powerful. At the very basic level, your savings will only grow if you spend less than you earn.

“Know your expenses.” This is another basic principle that emphasized in many personal finance blogs. It certainly helped us a lot. By knowing what and where we spent, it helped us developed plans to manage our finances.

“Be content.” I continually remind myself to be content and grateful of what we have. If I have the desire to buy new stuff (new car, new furniture, new computer, new ipad, etc..), I’ll ask my self “What is wrong with the old one? Is it broken? Why do I need a new one?”. When I first started working 11 years ago, I lived in a tiny studio apartment and had nothing in my name. But now, we have a nice house, 2 cars and plenty of stuff. Continually reminding myself helped me put things into perspective and to enjoy the things which we have.

May 10, 2012

Over the past few weeks we've been examining the investment science behind asset allocation. We learned that risk generally follows return. We learned that tilting small and value can boost returns. And we learned that blending investments near the efficient frontier can make even more efficient portfolios.

In our fall conference at Dimensional Funds, Eugene Fama presented the U.S. market returns from 1927 through 2010. He broke them down into 25 style boxes, each representing two deciles of size and value measurements. Style boxes were made popular by Morningstar as a visual representation of size and valuation. Morningstar divides each axis in thirds, but the data we looked at divided each axis in fifths to make a 5 by 5 grid. Each style box from micro-cap value to mega-cap growth had a computation of its monthly mean return and standard deviation to locate it on the efficient frontier.

If the capital asset pricing model (CAPM) represented the entire formula for risk and return, each of the 25 points would be along the efficient frontier in a relatively straight line. But this is not the case. Only 8 of the points were so obviously efficient that no other point had a higher return with a lower standard deviation. Three additional points were nearly as efficient so only one other data point was more efficient.

Given a longer time period, the efficiency of each box would possibly become more apparent, but this does not seem to be the case. At least four boxes do not appear to be anywhere next the efficient frontier because they have high volatility and low returns. There also seems to be a pattern of efficiency curving from large-cap blend down through mid-cap value to small-cap value.

As I have explained previously, not everything is on the efficient frontier. In this case, it appears as though small-cap growth has higher volatility and lower returns than every other category. This situation is both as unusual as it is unexplainable.It does not appear to be an initial public offering (IPO) effect. Most IPOs are trading below their initial valuation two years after the company goes public. Many of them fall into the small-cap growth category. But even after accounting for these, the category still has higher volatility and lower returns.

In the Fama-French three-factor model, the value factor has a greater effect than the size factor. This is because of the poor performance of small growth. Whatever the reason, reducing your allocation to small-cap growth, on average, should boost your returns and lower your volatility.

In the investing world the Sharpe ratio, named for Nobel prizewinning economist William Sharpe, measures efficiency. It is the amount of excess return above the risk-free rate divided by the standard deviation. I used the equivalent of 3.5% annually for the risk-free rate and computed Sharpe ratios for each style box. This produced Sharpe ratios ranging from 0.046 through 0.217. I also translated the 5-by-5 grid to the more familiar Morningstar 3-by-3 grid.

Sharpe ratios suggest where you should be investing your money. But they do not specify a corresponding asset allocation. We could use efficient frontier calculations. Over any specific time period, however, that might eliminate entirely decent investments that are just slightly off the efficient frontier.

Picking and choosing to invest in specific asset classes comes with a cost. And one of the important principles of efficient investing is that costs matter. Total stock market indexes come with very low expense ratios. Any investment that picks and chooses from among smaller asset classes has to justify returns exceptional enough to overcome higher expense ratios. A better investment strategy allows investments off the efficient frontier. But it underweights them by some ratio of their distance from the efficient frontier.

I made up my own algorithm for computing an asset allocation from a collection of Sharpe ratios. Much of investing wisdom is simple rules of thumb to help you make relatively smart decisions quickly, easily and accurately. It is not hubris to use such methods to approximate a precise decision in an imprecise world. In fact, that's the very way we got the Sharpe ratio. Perhaps in the future this methodology will be called the "Marotta allocation method."

The method involves first squaring the Sharpe ratio of each asset category. A small Sharpe ratio such as the 0.046 of micro-cap growth becomes an even smaller 0.002. The larger 0.217 Sharpe ratio of mid-cap value is not reduced as much and ends up as 0.047.

From the resulting numbers I created an allocation where each category gets a proportional allocation of the 100% total. Where the micro-cap growth starts as 21% of the size of mid-cap value, after squaring the Sharpe ratios, ends up as less than 5%. Squaring makes the small allocations tiny.

So the Marotta allocation method is a proportionally weighted allocation based on the square of each Sharpe ratio. Squaring the Sharpe ratio drastically reduces asset categories in proportion to their distance from the efficient frontier.

For the traditional Morningstar style boxes, this translates to investing only 3.31% in small-cap growth while allocating 18.31% to mid-cap value. And it means 47.82% on the value side and only 15.40% in growth. It also implies 37.84% in mid-cap and only 28.11% in large cap. These asset allocations may seem to tilt more toward the small and value side than many investors are familiar with. Historically, however, this allocation would produce better risk-adjusted returns.

The Butterfly Effect is the term given to the theory that small, seemingly insignificant actions can have far-reaching effects. The term was first used in the 1960s by Edward Lorenz, while modeling weather patterns. He theorized that the formation of a hurricane could be impacted by small movements, like that of a butterfly’s wing, occurring a long way away. It has been surmised that the only way to prevent these far-reaching events is to prevent the original small action happening.

So, what does the Butterfly Effect have to do with finances?

Let’s look at that definition again: small movements or actions can have a lasting effect, even after the action has stopped. When planning for financial security, it means that small savings or changes to spending now, can have far-reaching benefits in the future.

The reverse is also true though -- no savings or spending control now, will negatively impact financial futures.

The Butterfly Effect is about consequences; for every action, there is a consequence. Most of us learnt about consequences as kids – no TV until homework is done; no candy before dinner; being grounded for breaking the rules.

If you could fast-forward into your future, maybe to age 60, what would your financial situation be like? However it looks, it will be the consequence of actions you took and the choices you made along the way. If you want your future to be financially secure and stress-free, you need to consider what actions you need to be taking right now, to ensure that happens.

At the end of the day, we are responsible for the management of our own finances. We decide how and where to spend our money. No one else is going to look after us in retirement; the government certainly won’t by the time most of us get to retirement age.

Unfortunately, many people just don’t know how to manage their finances; some just don’t want to know, I guess. Modern society has us believing that we have to have it all and we have to have it now. This has led to enormous personal debt and financial hardship; I’m sure you know what I'm talking about.

But it’s OK; there are ways that you can change your financial destiny by using The Butterfly Effect for your future welfare. You make small choices and take small actions, starting now, to influence how your future is going to look.

You don’t have to squirrel away every spare cent and live frugally like a hermit, to achieve financial security. But it will take commitment to make regular small savings actions and sensible spending choices. Once you get the ball rolling in a savings account, it takes on a life of its own after a while. For example:

Let’s say you can save just $25 a month:

After 5 years, at an interest rate of 2%, you will have $1,576

After 10 years at an interest rate of 2%, you will have $3,318

If the interest rate was 4%, at 5 years you would have $1,657; at 10 years, $3,681.

If you are able to save $100 a month, the results are:

At 5 years, $6,304 at 2% interest; $6,630 at 4%.

At 10 years, $13,272 at 2% interest; $14,725 at 4%.

Now, these figures aren’t going to fund your retirement, but if you maintain this type of saving pattern throughout your working life, by age 60 the balance would be considerate. As you progress through your career, you should be able to increase the amounts you’re able to save. There are also many strategies that can help you improve on these results.

What are some other small actions that will Butterfly Effect you into a financially secure future?

They are the basics I've been covering here a lot lately on FMF. Check these out for more specifics:

A few of the tips listed in these posts bear repeating because the keys to success, especially for those just starting out or those looking to get their finances back on track. For instance:

Set financial goals. If you have no goal, you don’t have anything to work towards. Decide what you want to achieve financially and start to fund those goals immediately.

Create a written budget and work to it. I know, you hate budgeting. So call it a cash flow plan. The truth is that creating and managing a cash flow plan really is the key to financial security. You simply must know where your money comes from and where it is spent. A budget shows you very clearly where you need to trim spending; it also shows you how much you can save and invest in your future.

Establish effective saving habits, starting today. If you have been in the habit of spending everything you earn, this is going to cause you some short-term pain. According to the Butterfly Effect, this short-term pain will have far-reaching benefits for you. Regular saving, even of quite small amounts, is the key.

Once you see The Butterfly Effect is at work on your finances, you will discover other small choices that will help you work towards financial security and peace of mind. It is never too late to start making those small movements towards a good financial future.

A few months ago I was traveling with a co-worker who's about 15 years or so older than I am. The conversation turned to personal finances and then, specifically, to long-term care insurance (LTCI). I asked him what his plans were and he took me through the issues he and his wife had discussed and ultimately what they had decided.

I've been thinking about this topic off and on and as a result have collected a few pieces I thought I'd share with you.

You should purchase [LTCI] when it is financially affordable. Younger people who buy it now will have the benefits of longer protection with lower premiums than if they wait until a later age. Of course, before you purchase it you should also consider life insurance and disability insurance to protect your income.

I'm not sure I'm in the "buy it as soon as you possibly can" camp, but I do think it's better to buy it before you show any signs of needing it but are still close enough to potentially using it that it's not 40 years away -- which for most people would be in their 50's to early 60's.

Also, I'm starting to see where LTCI fits into the pattern of insurance throughout a lifetime. It goes something like this:

During your working career, you need medical, life, and disability insurance to protect you and your family in case something should happen to you (and your income).

As you get older, you become self-insured and can drop life insurance. For people who are at least decent money managers, this is 20 to 30 years into your career on average. (We took out 20-year policies when we had our first child and we will let them expire when he's 20. By then we will easily be self-insured.)

As you start to transition from work to retirement, you need to add LTCI to the mix -- let's say at age 55, but it can vary widely.

As you retire, disability insurance goes away and medical insurance transfers to Medicare (and potentially gap insurance to cover what it doesn't). LTCI remains and is your primary insurance at this point in life.

For instance, he gave an example of a 55-year-old couple in good health buying a typical “three year” policy—one that uses a daily rate of $150 over three years to calculate a maximum benefit payout. (A three-year policy doesn’t mean that it only pays benefits for three years. Rather, the time period is used to calculate a total pool of money that can be tapped over time, as needed.) The couple would pay about $2,000 a year in premiums for a policy with a current value of roughly $164,000 for each spouse (at a 3 percent inflation rate, the value would grow to $350,000 for each, at age 80).

By comparison, the same couple would pay more than double that premium — about $4,335 a year — for an unlimited policy.

Not the cheapest insurance in the world, but it's not crazy expensive either. I pay $3k or so for disability insurance each year and that's just for me. So to pay $4,335 to cover both my wife and me isn't out of the realm of reason. Then again, it's a lot more than the cost of life insurance!

Not everyone will need long-term care insurance (LTC), but everyone needs a long-term healthcare plan. Your long-term care plan should incorporate the following: facts about you (and your spouse, if applicable), your age, your personal health, longevity of lineage, your retirement income and assets, your tolerance for risk, the costs and demographics of long-term care in your geographic area and information about any long-term care insurance that you own or have considered owning.

They then cover the various considerations we all need to make when looking at LTCI before they get to this summary:

In addition to making sense of the myriad of moving pieces in the policies, the problem that scares away most prospective insureds is the bottom line price. If you buy the policy designed to insure virtually every possible scenario you may encounter—say, a $200 per day benefit guaranteed to pay a benefit for the rest of your life—you will, indeed, find shocking premiums that may send you packing. The solution, however, for many people is to partially-insure the risk of a long-term care incident or incidents. Consider a policy with a reduced benefit, like $100 or $150 per day, and a shorter benefit period, like three or five years.

This seems reasonable to me. To use LTCI for a major part of potentail needs, but to also partially self-insure yourself through your own retirement savings.

Finally, I ran into a couple resources dealing with LTCI. The Forbes article above links to an app that helps you compare LTCI options and start on estimating pricing. And this cost of care map helps estimate the sorts of costs you may be looking at covering. The cool thing is that it allows you to compare one state's cost to another's -- so if you're thinking of moving in retirement, you can see if your LTC costs will increase or decrease.

So I'm still researching this subject, not 100% sure of what I'm going to do. How about you? How are you dealing with/thinking about this issue?

In previous chapters we’ve talked about how to control your spending through budgeting and the importance of spending your money wisely by becoming a smart, well-informed consumer. But the one spending angle that we haven’t talked about yet is this: once you’ve decided to buy something, how do you pay? I mean this in the simplest, most literal sense: you’ve decided to buy something, the seller wants their money, and you’re willing to exchange money for whatever it is that they are selling—now what? Most of the time you have a choice, and the usual suspects are currency (bills and coins), check, debit card, or credit card. Does it matter which one you pick? Are there smart ways and not-so-smart ways to pay? Or does it simply not matter, since it all ends up coming out of your pocket in the end, one way or another?

Well, it does matter! This is a multiple-choice question that you’ll face dozens if not hundreds of times a year, and many thousands of times over the course of your financial life. As you might suspect, if there is one best way to pay for what you buy, then you should always use it, every time you have a choice. Well, there is one best way, and here is your rule:

Always use a credit card to pay, but never use credit.

What? Isn’t “using a credit card but not using credit” an oxymoron, like “jumbo shrimp” or “awfully nice”? No, it’s not—and here’s why: when you pay your monthly credit card bill, in full, before the balance is due, then you aren’t charged any interest. So your strategy is to use a credit card but to pay the monthly balance each and every month without fail. If you do this, then using a credit card is perfectly safe and offers some critical advantages over all the other ways that you can pay. (It’s even better if you arrange to have your complete credit card balance paid each month automatically; just be sure to examine every transaction during your budget cycle for fraudulent or inaccurate charges.) But if you don’t pay the monthly balance in full, on time, each and every month, then credit cards are extremely dangerous to your financial health. Because this point is so vitally important, I am going to restate the rule in a little bit longer form so that when you look back to refer to the rule, you won’t forget it:

Always use a credit card to pay; but always pay the monthly balance, in full, on time, each and every month, without fail.

To understand why credit cards are the best choice in the first place, let’s first summarize the problems with the other three choices. Currency is a bad choice, as you already learned in the budgeting chapter, because it leaves no trail and makes the compare and learn steps of the budget cycle a nightmare. Checks are better, but there can be a significant time lag between when you write the check and when the recipient cashes it, and this also complicates the budget cycle. In addition, checks are slow and inconvenient at the point of purchase.

Before we go on, let’s make sure that you understand the difference between debit cards and credit cards: if you don’t, that’s okay—lots of people don’t—and these cards are virtually identical to the naked eye. A debit card allows you to spend the money in your checking account, but not any more than that. Debit cards are like checks in this way; if you try to spend more than you have in your checking account, either the transaction will be declined or you’ll be charged an overdraft fee. But a credit card is different: it allows you to spend any amount of money up to your preauthorized credit limit, whether you currently have that much in your account or not. Each month, you are billed for the balance. If you pay the balance in full, you aren’t charged any interest, and then you go on to the next month. If you pay only part of the balance, then you are charged interest on the unpaid portion—usually at an extremely high rate. That’s where the danger comes in!

So back to our comparisons: debit cards are great for convenience, but they have two disadvantages. First, they are subject to something called blocks: when you make certain purchases such as buying gas, paying for a hotel room, or renting a car, transactions are often recorded for a much higher amount than you actually spent. A few days later, the high charges are reversed and the actual ones substituted in, but in the meantime the block could cause you an overdraft problem. The second problem with debit cards is that they don’t help you with your credit score.

But credit cards solve all these problems, and that’s why they are the best choice. They are convenient at the point of purchase, and the budgeting cycle is a breeze because all of your transactions are conveniently summarized each month, online, in easily downloadable form. There are no timing differences to deal with, and no blocks. Best of all, responsibly using credit cards improves your credit score. And you already know what responsibly means—paying off the balance in full, each and every month, no matter what your right brain says. Using a credit card is like driving a car—safe and indispensable if you know what you are doing, and very dangerous if you don’t.

While using credit cards without using credit is the best strategy for you eventually, it may not be the best strategy immediately. There are two reasons for this. First, you may not be able to qualify for a credit card yet (or the credit cards that you do qualify for don’t meet our criteria, which we’ll cover in the next section). Second, you may not yet have enough experience with controlling your spending through budgeting to trust yourself with a credit card. If either of these applies to you, then you can use a debit card as your interim strategy. Think of your debit card like training wheels when learning to ride a bike. As soon as you can qualify for a good credit card and you feel confident in your spending control skills, then switch over. Finally, if you’re having trouble qualifying for a card because you don’t have enough financial history, there is a special kind of card called a secured credit card that can be another excellent intermediate step—check it out.

Recently, I've had some issues with choosing whether to repay my college debt aggressively OR pump money into a savings account. I'll give a little bit of background that may be necessary.

I'm 23 years old living at home so I do not have any rent expenses although I plan to move out towards the end of the year/beginning of 2013. I have 10k saved in an online savings account with another 1k in a personal checking account. I net roughly 3200 a month. My total loan balance is about 55k. Minimum payments to the different lenders are at 150, 258, 53, and 126 with rates at 7.8%, 6%, 5%, 5.5% respectively.

After I reached 10k in my savings account, I stopped 'saving' and pumped about 1400 into the loan with the highest interest rate (this loan as a balance of about 10k) while paying the minimum payments on the rest. My thinking was that if I could knock that loan out before I moved out it would be one less expense to worry about.

Recently however I have been second guessing my choice. I'm worried that if I do not continue to save money I won't be preparing effectively for some of my future goals. I have just started to put money into my 401k but a very small amount. I'll be increasing the contribution once my company match kicks in.

Moneyland highlights a recent study that says recruiters spend an average of six seconds reviewing an individual resume. The study used a scientific technique to analyze how long professional recruiters reviewed candidate profiles and resumes. It found that recruiters scan quickly for education requirements and career progression. Based on whether or not they see these in six seconds, the resume either gets moved ahead or rejected.

Obviously this has great implications for job hunters. Your resume needs to make an impression and make it quickly. Here are six steps Moneyland suggests to help you accomplish this goal:

1. Don’t be Creative2. Put Your Expertise and Skills at the Top3. Don’t Make it Too Long4. Ditch the Photos5. Don’t Focus on Your Personal Achievements6. Have it Professionally Made

Here's my take on these:

1. You have SIX SECONDS to make an impression. You can help the reader out a bit by following a standard format -- one where he doesn't have to spend four of the six seconds figuring out what's going on in the resume (and where the key information is.) This is why you should use a standard resume format (I prefer a chronological format -- with the most recent job first) and not get too "out there."

2. The top of the page is your most valuable space. That's why I don't like to see an objective there -- it wastes space on something the employer doesn't care about: what YOU want out of life. All he wants to know is what you can do for HIM. This said, you could make an argument for putting an "experience summary" at the top -- something a reviewer can read in six seconds (maybe bullet points) that contains your most compelling successes/accomplishments.

3. I prefer one page for those with 10 years or less experience and two pages for those working longer if needed. From there the resume can get longer if you're applying for top-level jobs. Of course these are general rules and can be adjusted for special circumstances. But you have to be SURE that special circumstances apply to you. (Also, if they really only take six seconds, probably only stuff at the top of page #1 is vital. This is not to say the rest is not useful, but if the first six seconds impress, it may not matter much how long the resume is.)

4. NO PHOTOS!!!!! (Unless you're in an industry that requires them -- like on-air personality for a TV show or modeling.) Do you really want your six seconds spent on someone looking at your photo?

5. You don't need any sort of personal information on your resume unless it helps you get the job. For instance, the fact that Joe is a marathoner might help him get a job designing running shoes at Nike, so he'd have to think through whether or not this was more important than something else. But if Joe was applying for a job as a teacher, there's probably better info to include than his running pursuits.

6. I am NOT in favor of paying someone to write your resume. It's like personal finance -- if you take time to learn what works and what doesn't, you can do a great job yourself. Then again, if you're totally clueless and/or don't have the time to learn, it may be worth a $100 investment to get a job that pays $50,000 a year.

One of my favorite internships was at a national television morning show called the Daily Buzz. The show tapes out of Orlando, where I spent my junior year at University of Central Florida. That year, the Daily Buzz brought on eight interns, and we had a slew of duties: maintaining the greenroom, welcoming guests, working closely under the show’s directors and producers, assisting with segments, prepping the hosts, coordinating segments, and even appearing on the show. Before my internship, I knew nothing about television shows and how they were actually produced. This internship was especially challenging because I had to be in by 4 a.m. three days per week. I stayed from 4 a.m. until 10 a.m. while they filmed the show. My roommates would be going to sleep, and I’d be waking up for my internship. It was quite the experience!

One morning I was instructed to make coffee for the guests in the greenroom. It’s a task some would call menial, but someone does need to make the coffee for the guests and keep them comfortable on a morning show. I walked into the break room that the Daily Buzz shared with a few other offices in the building. I looked at the coffee machine, honestly hav-ing no idea how to use it. I wasn’t a coffee drinker at the time. The coffee machine was huge and had buttons everywhere, so I pressed one, not really knowing what would happen. Unfortunately I pressed the wrong button and coffee started spewing everywhere and flooding the break room floor. No one else was in the room. I started to panic and sprinted down the hallway to find someone who could help me. Clayton, an anchor of the show, was standing in the hallway and came to my rescue. We went back into the break room where people were standing and saying, “Who flooded the break room?” Clayton took the blame and helped me fix the coffee machine, clean up, and make a fresh pot for our guests. An internship is a time for you to learn, make mistakes, and fix them. If I started my first job at Creative Artists Agency (CAA) and didn’t know how to make coffee, I would have been in trouble. Since I learned at my internship, I was prepared.

One of the reasons internships are controversial is because critics clas-sify intern duties as mindless tasks. As you can see, everything has its place and even fetching coffee can be beneficial for students as long as that isn’t what they spend the bulk of their time doing. Last year the New York Times published an article called “Unpaid Interns—Legal or Not?” that further explored the controversy within the internship space. Are unpaid internships illegal? What can students do to protect themselves at their internships? This article spurred debates among everyone involved with the internship equation—students, professors, parents, employers, and career coaches. Everyone took free rein to blast their opinions on internships.

Each year I visit colleges and universities worldwide and meet thousands of students energized by the subject of internships. They are driven, passionate, hard-working, and resilient in the face of any negative talk around the topic. They understand the value of real-world experience and building professional contacts—whether or not the work pays or is considered glamorous. They hear what critics say about internships being exploitative and termed “slave labor.” But they keep going. They keep looking for opportunities. Although criticized for being part of a trophy generation and acting entitled, these students want to succeed and they want it bad. But until everyone shares this viewpoint on the power and importance of an internship, the controversy will continue.

The purpose of this book is not to pick sides or place blame, but to point out the guidelines that do exist. I teach students to walk into any situation prepared. To be prepared for an internship means understanding the rules in place to protect interns. I know you might consider this the boring chapter, but it’s actually one of the most important. As a student, you should pride yourself on being informed. This will help you navigate your way through any unfair or uncomfortable situations that could potentially occur. I rarely hear about problems at internships, but they do pop up every so often. The best thing that you, the student, can do is be prepared. I’m calling this the cautious approach.

The majority of students and employers are unaware of the guidelines associated with internships. In this chapter, I aim to fix that and clearly explain each of the six criteria that legally define an unpaid internship. I also discuss issues involving sexual harassment in regard to paid and unpaid interns. The end of the chapter contains a list called “Your Rights as an Intern,” which provides clarity and justification to students who are scared to speak up for themselves. To maintain a sense of transparency with my readers, I want to reiterate that I am not and will never claim to be a legal expert. Everything in this chapter is pulled from the US Department of Labor and EEOC’s resources. The explanations provided are my translations of each rule to help students better understand what the guidelines say. And of course, laws change and different situations lead to different issues to consider, so if you have concerns or questions, you can always consult with a lawyer or human resources specialist. Knowing that, let’s proceed and I’ll walk you through exactly what you need to know to ensure you walk into every situation an informed intern.

Understanding the Fair Labor Standards Act

The US Department of Labor (USDOL) created the Fair Labor Standards Act (FLSA) Fact Sheet #71 to protect students from employers taking advantage of them and using them to substitute for actual employees. Keep in mind, the entire FLSA covers youth employment issues and is not limited to internships. The Fact Sheet # 71 that I will be referencing throughout this chapter is titled Internship Programs Under the Fair Labor Standards Act. (If you want to refer to the complete document, you can view it here. To find a link and pull up the FLSA, go to the United States Department of Labor website at dol.gov.)

To make sense of this document, I broke it down into sections and bulleted all of the important points that you should note. Before we begin, I want to explain that there is a distinct difference legally between the word employ and the word intern. Here is how those terms are defined in the FLSA Fact Sheet #71:

Employ: To employ means to suffer or permit to work. Covered and nonexempt individuals who are suffered or permitted to work must be compensated under the law for the services they perform for an employer.

Intern: Internships in the “for-profit” private sector will most often be viewed as employment, unless the test described below relating to trainees is met.

The “test” they refer to in the above definition of the word intern are the six criteria we are about to explore. For an unpaid internship to be legal, the opportunity must meet all six criteria. Just to clarify, these criteria are for unpaid interns. Paid internships do not need to abide by these.

FLSA Point #1: The internship, even though it includes actual operation of the facilities of the employer, is similar to training which would be given in an educational environment.

The internship must be a learning experience. Students should learn how a specific company is run and how to work in many capacities within that industry by listening, observing, and actually executing entry-level tasks. Each of those tasks must come with clear instruction and consistent supervision. Does this imply that you need to be watched like a hawk at all times? I should hope not, but employers must train you to complete tasks before assigning them.

Additionally each task must have a benefit for you, the student. Determine if the task you are given has a learning objective attached by constantly asking yourself, “What am I learning from this?” and “What will I get out of doing this task in the long run?” You can also ask yourself, “When might I use this skill in the future?” Writing down some of the tasks at your internship and what you are personally gaining from them will remind you what to include when updating resumes and preparing for interviews. I will explain this technique and how to write down learning objectives in chapter 8.

Let’s say an internship coordinator is having you set up a Facebook page for their business. This helps you take what you already know about social media and apply it in a professional manner. Setting up and running a Facebook page is definitely something you could be asked to do as an entry-level employee, and knowing how to do this efficiently will help you with future career plans. If the Facebook page is successful, this will give you a success story to speak of during future interviews and will also give you social media experience to talk up in your cover letter.

FLSA Point #2: The internship experience is for the benefit of the intern.

Notice this says the benefit of the intern and not the benefit of the employer. Unfortunately employers don’t always understand this and use interns to do tasks directly related to generating revenue. Commonly this happens when interns act as salespeople and sell directly to clients. There is a big difference between an intern running a social media campaign that indirectly grows a brand and an intern selling directly to a client. To prevent this from happening, read over internship postings very closely. Be cautious of words like sales, commissions, and making money. Go with your gut instinct. Do you feel that your efforts alone are generating income for the employer? If yes, speak with your career center and get their opinion. Let them guide you on how to deal with this situation.

FLSA Point #3: The intern does not displace regular employees, but works under close supervision of existing staff.

Point #3 also relates to an intern acting as an employee and generating revenue for the employer. Since 2009, we’ve seen an increase in layoffs nationwide. We must make sure that extra interns aren’t brought on board to replace actual employees.

Mark Cuban, a famous businessman and controversial blogger, wrote a blog post where he expressed his frustration with the roadblocks he encountered when wanting to start a new organization within an existing company that was solely run by interns. He thought it would be a great learning opportunity for students to create a brand. He ran this by his human resources department, and they told him he was not allowed to do that. Interns must be supervised, they cannot generate revenue, and they cannot replace actual employees. Mark Cuban’s intentions were to provide students with an experience like none other, but this is where the FLSA rules come into play. Ask yourself, could the company run without me? If the answer is no, you have a problem you need to discuss with your career center as soon as possible.

FLSA Point #4: The employer that provides the training derives no immediate advantage from the activities of the intern; and on occasion its operations may actually be impeded.

The intern should be learning from the employer and assisting them, not doing their job for them. This point reiterates what we already covered and again says the intern shouldn’t be directly generating revenue or participating in unsupervised activity. It also tells the employer that their operations might actually be “impeded” or slowed down because training an intern to do a task can be time consuming. You will notice many of the criteria are saying the same thing in different ways to protect the student.

FLSA Point #5: The intern is not necessarily entitled to a job at the conclusion of the internship.

Periodically, Bloomberg Businessweek ranks their top fifty internship programs and lists their retention rates from intern to employee. Companies like PricewaterhouseCoopers retain close to 89 percent of their interns each year. IBM retains approximately 40 percent of their interns. Several paid internships report retention rates, where the majority of unpaid internships do not report this information. Interns must understand that an internship in no way implies that a full-time job will be offered at the end. The internship should have a start date and an end date to show that it’s not an open-ended opportunity. In chapter 9, I’ll provide strategies for turning the internship into a full-time job. But it is important to walk into the internship knowing there might not be a pot of gold at the end of the rainbow—or, in this case, a job.

FLSA Point #6: The employer and the intern understand that the intern is not entitled to wages for the time spent in the internship.

An internship is a two-way street, and when students start unpaid internships, they must completely understand that they are not entitled to any money under any circumstances at this position. During an interview, it is appropriate for a student to ask about wages or potential travel reimbursement. Once employers state that the internship is unpaid or paid and what they will or will not reimburse, the discussion is closed.

The following is the latest post in my "Reader Profiles" series. Each post in this series details the financial situation and challenges of an FMF reader. The purpose of this series is to help us all identify with people like us (in similar situations -- not all will be, of course, but eventually I'm sure you will find someone like you here), get to know the frequent commenters on the site, and hear some financial wisdom/challenges from people other than me.

If you're interested in contributing to this series, then drop me an email. The series seems to be very popular with readers and I need a steady stream of new ones to keep it going.

Next in the series is FMF reader EH. She answered my questions (in red below) as follows:

Please tell us a bit about yourself.

I am a single, 35 year old woman living in New York City. I have been working as an Executive assistant at a pharmaceutical company for the past 9 years and recently completed my MBA with dual concentrations of Corporate Finance and Marketing. I am seeking to change my career path to the finance or marketing fields, but am having difficulties in my search. I find that I have so much education that I am ruled out of entry positions, but not enough experience to capitalize on opportunities for seasoned professionals who have similar educational experience. I also have a wonderful 6 year old dog who makes me smile every day.

Describe your financial situation (who works in your family, how your income is (general), how your expenses are, etc.).

I have been very fortunate financially. My parents valued education, and I am lucky to have gotten my BFA debt free. My MBA was partially subsidized by my work and I paid the remainder of tuition out of my savings. I have no student debt. I own a 1-bedroom apartment in a co-op in Manhattan which was bought in early 2008 and I have $111k remaining on the mortgage which is a 6%/30yr loan from my parents. I rarely eat out. I receive my television entertainment via an antenna and I avoid personal expenses like cabs, pedicures, housekeepers, and frequent haircuts. Even my dog is frugal- she gets all her baths in the bathtub at home! I pay my credit card bills in full every month. I do not own a car (one of the benefits of NYC is the excellent public transportation). My employer has a 401k match of 4.5% and I currently invest 9% of my income into the 401K plan. My base salary, before overtime, is $78k.

Monthly Expenses:

Maintenance and insurance: $769

Mortgage: $1200

Food: $250

Utilities: $70

Phone & Internet: $70

Monthly subway ticket: $104

FSA: $100

Pets: $60 (we had a car accident last year, so this number is now higher to account for the unexpected)

Toiletries/Shopping: $100

Savings: $200

Household savings:

Roth IRA: $79,000

401K: $161,000

Mutual Funds: $36,000

Laddered CDs: $37,000

Home equity: $334,000

Cash savings: $3,400

What are the current financial issues you're facing (saving, paying off debt, etc.)?

Currently, I’m trying to find a place of balance where I am saving an appropriate amount and not totally living like a college student off of ramen noodles every night. I am fortunate to work a lot of overtime at present and I am plowing 100% of that income into pre-paying my mortgage. It would be difficult to find another guaranteed method of making >6% on that income.

What are your plans for the future (retire early, build your career, etc.)?

I have a goal of being debt free as soon as possible and having at least $50k in liquid reserves. With my MBA, I am currently trying to build my career and expand my income. I have no plan to retire early, but want to be sure that when I do choose to retire, I am fully prepared financially. Ideally, I’ll eventually find someone to settle down with, maybe even adopt a child with, and hopefully they will have their financial act together.

I’m a big fan of using mint.com to keep track of all my finances in a one-stop-shop place. Other maxims I have found to be useful are: Spend less than you earn. Always pay yourself first by saving a little bit, even if you are living hand-to-mouth, week-to-week. When you get a bonus/tax return/ upgrade in salary, try not to change your spending and instead save/invest that money.

Achieving financial security is greatly dependent on our ability to make wise choices when it comes to spending money. Spending, not earning, is the key to financial security (though both are important, of course). And yet we live in a society where over-spending is almost the norm. The result for many people is a pile of debt and all the nasty struggles associated with it. It's certainly not the pathway to financial security.

IMO much of the over-spending in America stems from the fact that we've simply forgotten the difference between a need and a want. So I'd like to review the two and give some suggestions on how people with spending problems may be able to get a reign on their money.

Here are the most basic definitions of a want and a need:

Need: something you must have to survive.

Want: something you would like to have.

A ‘need’ is something that you must have to survive. This includes a roof over your head, nutritious food to eat and clean water to drink, clothes to wear that allow you to be dressed appropriately and keep you warm in cold weather, health care and transportation.

A ‘want’ is something that would be nice to have; that you have formed an emotional attachment to having but that you could survive without.

Let's review a few examples to clarify the definitions.

Need: Clothing. Simple, basic clothing, nothing fancy. It doesn't even need to be new. It only needs to fulfill its purpose of keeping us warm/protected from the elements and cover our bodies appropriately. Example: a simple shirt from Walmart or a thrift shop for $15 (at the most).

Need: A car to get to work (assuming there's no other form of transportation.) Most likely a used car. As long as it's in good working condition, it's fine. Cost would vary based on miles, but let's go with a respectable $5,000.

Want: A new, imported sports cars from a premium auto manufacturer. Costs vary as well, but would be well over $50,000 or so.

Need: A place to live. Could be an apartment, a small house, or even a room in a friend's place. Cost would be on the low end of what others spend.

Want: A 3,000-square foot custom-built home that has the latest upgrades available and two or more bedrooms than you have people in your home. A pool is a must too. Oh, and it needs to be on a lake. Cost is as high as is affordable -- as long as both spouses keep working to afford the maxed-out monthly payments.

Before some of you blow a gasket, let me give a few clarifying thoughts:

These are extreme examples at different ends of the spectrum to provide an illustration. Don't get all wacky on me (or feel content with your spending for that matter) simply because you see the "wants" listed above as being extravagant.

Most of us will be closer to the needs on the list. For example, I need a polo shirt for work ($20) but I prefer a Nike golf shirt instead ($35). Yes, it's more than I need and therefore is classified as a want, but it's well below the high-end $600 shirt. This is the area most of us operate in and it's fine -- as long as all of our spending decisions don't become a series of ever-increasing wants with higher and higher costs.

I'm not trying to be a kill-joy. You're earned your money and you have the right to spend it how you like. And there's a lot to be said for enjoying the fruits of your labor. So go ahead, live it up. You deserve it and personally, I'm fine with that -- it's what I do. I spend much more than needed in select areas. I live it up in certain areas and with certain purchases while being thrifty in other areas. It's this balance that I think works the best for most of us and it's what I recommend.

Now that we've got that out of the way, let's address those who may have a hard time seeing a want as a want -- they see it as a need. They HAVE to have that designer shirt, the new sports car, and the huge house. Yes, it's killing their finances, but they can make any progress. There's simply no question in their minds -- they have to have what they have to have.

So how do you change poor spending habits of a lifetime? Here are some great tips to work out needs from wants and curb unnecessary spending:

Change your attitude toward spending. Determine your priorities in life; work out what is really important to you and make a list. Keep this list handy so you can refer to it frequently. When you are shopping and you are tempted to buy, ask yourself “Is it in line with my pre-determined priorities?” and “If I buy this, will it prevent me having money for my priorities?”

Consider before you buy. Before you make any purchase, ask yourself “Do I really need it? Can I survive without it?”, “Do I have something at home that can do the same job?”, and “Is there a cheaper alternative that will achieve a similar result?” Many times the answers to these questions will halt spending immediately.

Avoid impulse buying. Stop and think before handing over your money. Walk away while you consider your spending options. This strategy is a great way to help you determine your ‘wants’ from your ‘needs’.

So, does all this mean that you should only ever buy things that you need? Certainly not! It is OK, even beneficial, to treat yourself to something you really want; the secret is to do so with your eyes wide open and only when you can really afford to. Understanding the difference between your wants and needs will help you make wise spending decisions. This is important because the small spending decisions you make now, will positively impact your financial security well into your future.

May 07, 2012

One of the keys to making the most of your career is to develop and grow a healthy network. But when some people hear the word "networking", they think of the old-time, sleazy definition of the word -- the "using" others in a what's-in-it-for-me fashion. That's not the sort of networking that moves your career ahead. The sort of networking that does work is one that's mutually beneficial -- where you give/help as much as you get.

1. Hello: Just say hello or give people a quick update when something interesting happens.

2. Remember things: Listen [when they share personal stories]. Then follow up later [to ask how it all went].

3. Offer to help: Ask "What is your challenge right now? How can I help you?"

4. Positive feedback: When you [give positive feedback], it stands out, is appreciated, and is memorable.

5. Say thank you: Thank people a lot and often.

6. Follow up: When you ask someone in your network for something and she follows through, let her know what happened.

7. Make an introduction: Be astute about helpful introductions you can make.

8. A point of interest or enjoyment: If you remember what is important to people and what they like, it gives you an opportunity to point them to great stuff that you run across like articles, movies, books, music, and events.

9. Photos: Use photos of things you've seen and done, yourself, your family.

10. Video mail: It is a personal and standout way to say hello to someone.

These are great, great tips IMO. And they all seem to come back to one thing: they make you likeable and helpful. And people want to help likeable and helpful people!

As for the tips above, I have some specific thoughts on some of them. I'll give these thoughts with the number that corresponds to the tip above. Here goes:

5. I know a guy who ALWAYS thanks people a lot -- for helping, for volunteering, for almost anything -- and people LOVE him. People like to be appreciated and those who show appreciation grow and develop their networks.

6. I love it when I can be helpful to someone, but in most cases I never hear anything back unless I make the effort to contact someone. If that person would instead get back to me, it would make me much more willing to help him in the future.

8. I do this quite often. For example, I have a casual acquaintance who has an interest in bed bugs (he was looking at investing in a company that killed them.) Every article I see on bed bugs (and there are many more than you'd think -- I find a new one every few months or so) I send to him -- just the link and a short note. It keeps us in touch and communicating and is fun for us both.

And while we're on the subject of networking, here are my main ways of networking with others:

Volunteering. I serve on committees for two charitable organizations and am the president of the board for a third. I make a lot of contacts through each of them while doing work I love and helping out others. I plan to write more about my experiences volunteering in future posts.

Lunches. Once a week I take out someone to lunch. We catch up, talk about what's going on in our lives, etc. It's a good way to connect on a deeper level.

In addition to these, my plan is to add a profile to LinkedIn this year. We'll see if I get to it or not -- it's been on my list for a while -- but I'm hopeful 2012 will be the year it happens.

No matter what the common perception of internships might be, they are, inarguably, the most valuable experience for today’s college student. And the statistics are there to back it up. In 2010, students with internships on their resume received a greater number of job offers than students without internships. Additionally, students with internship experience received higher salary offers for their first jobs than students without internships. The internship remains the only proven way to provide students with the entry-level job experience, training, and relationships necessary to better prepare them for their career path.

Perhaps the strongest argument for internships stems from those who started as interns and have gone on to be successful. I point you to the likes of Oprah Winfrey, who started as an intern for a local CBS affiliate in Nashville; award-winning journalist Brian Williams, who started as an intern for the Jimmy Carter administration; and fashion designer extraordinaire Betsy Johnson, who started as an intern for Mademoiselle magazine. Despite these facts, statistics, and examples, many students across America remain unconvinced and unwilling to consider internships. They don’t want to focus their attention on gaining the practical workplace experience usually needed to land a job after college. These students have not experienced their click moment.

I begin my internship presentations at universities by asking students to raise their hands if they’ve had an internship. Approximately 20 percent raise their hands. Those 20 percent are on the right track. The other 80 percent will be on the right track soon—they just need a bit of encouragement. But why does this happen? What is the disconnect between Gen Y and the concept of internships?

Many call this a generational issue, but I say it’s the difference between knowing and doing. I argue that students do know where they want to go and how they want their life to end up—at least in a general sense. What they do not know is how they are going to arrive at their chosen destination. People tend to focus on the end result and overlook the roadmap that shows students how to get from point A to point B. When I was younger, I was constantly asked, “What do you want to be when you grow up?” This question forced me to think about my career goals but failed to show me how I could achieve them. Students understand the importance of landing a job after college. I don’t doubt that. However, they often have a lack of guidance for the time in between.

I, too, ask students what they want to be when they grow up. The difference is that I follow up the question by asking how they are going to get there. How will you achieve your goal? What internship can you get to further your understanding of a specific industry?

Before we dive into the current internship space and explore internship trends, I want to explain why an internship is a necessary tool for one’s future. Below I’ve outlined five key components of an internship that are crucial to lifelong career success: hands-on education, networking, resume building, gaining references, and pursuit or elimination. To be clear, these five components apply to both paid and unpaid internships.

Hands-On Education

A hands-on education is something that can’t be achieved in the classroom. Your internship not only teaches you what goes on within a company but also provides you with the opportunity to execute and perform these tasks while under the proper mentorship or supervision. As an intern, you handle administrative tasks, sit in on meetings, and develop a clear understanding of how executives do what they do. You will make mistakes because you are learning. In fact, you are expected to make mistakes. These mistakes help prepare you to excel postcollege, when you are on the company’s dime. This knowledge and practice will place you above your competition and ahead of the crowd for job interviews. Mary Mahoney, assistant director of Career Services at the University of Tennessee says, “If you were an employer, who would you rather hire: the student with no previous experience or the student who’s had intense training and experience in your field and is familiar with your processes, software, and materials?”

Remember, according to a 2010 Student Survey conducted by the National Association of Colleges and Employers, 51 percent of students have had internships by the time they graduate from college. It would be disappointing to miss out on a job postcollege because the person you are up against had had an internship and you hadn’t.

Networking

As an intern, your job is to meet all the people in the office and give them a reason to remember you. Potential contacts hear about job openings within their personal and professional networks, and you must be able to tap into those networks as an intern. Your ability to keep in touch with and nurture these contacts will be crucial to your long-term career goals. Do you know how I landed my first job out of college at Creative Artists Agency, the largest talent agency in the world? I called up a contact that I met at my FOX internship and asked him to put in a call for me. One week after moving to Los Angeles, I lined up an interview and landed the job. In chapters 8 and 9, I’ll provide tons of networking tips to ensure you are able to properly leverage your new contacts.

Resume Building

Employers judge candidates by this one piece of paper. If it doesn’t list an internship and speak to the candidate’s professionalism, experience, and capabilities, there is a strong chance it will get thrown away or deleted. I’ve termed these resumes “trash can resumes” and will continue to define what qualifies (and how to avoid) them in chapter 3. Employers spot an internship on a resume and they instantly see dedication, a strong work ethic, and a sense of focus from the student. Internships say to an employer, “I care about my future. I dedicated time to hone my skills and work on my craft in order to excel in my future.”

My first out-of-state internship was in New York City at Backstage, a theatre trade newspaper. The day I phoned the company to ask about internship openings, the editor-in-chief, Sherry Eaker, answered the phone. Her first question was “Have you ever had an internship?” She was pleased when I answered, “Yes!” When a student’s resume says “internship,” it speaks to experience.

References

You should already know how to properly sell yourself—but do you have professionals willing to sell you? Are there executives who can speak intelligently and truthfully about your professional skills, attitude, and how you function in the workplace? Internships provide a place to gain these references and continuously prove yourself to a variety of professionals. Each task you perform has multiple purposes and will affect multiple people. Make sure each person you assist can speak to your capabilities. By doing this, you turn a contact into a reference. Jennifer Rupert, assistant director of Career Development at the New School in New York City explains, “People get to see you in action. They experience your work ethic and enthusiasm. In short, they get a chance to know you and become personally invested.”

These references will write you glowing letters of recommendation in the future. In other words, your relationships with internship coordinators and executives can drastically affect your future. Keep this in mind from day one of your internship.

Pursuit or Elimination

The last component of an internship is my favorite: pursuit or elimination. Students worry their internship experience might not be successful. But here’s the thing, even less-than-stellar internships are beneficial. They establish what you like and what you don’t like, what you want to pursue and what should be eliminated in terms of your future. Spend one semester interning at a company and determine if that’s the right fit. Don’t waste time doing this postcollege. Remember that experience—whether positive or negative—is still a valuable resume builder. No matter what the outcome, you will leave an internship more informed than when you walked in. You will gain knowledge of that industry, learn how the specific office is run, understand administrative tasks, and leave with contacts.

In 2005, I accepted an internship at NBC Universal in their on-air promotions department. The entertainment industry interested me, but I knew nothing about this specific part of the business. The internship provided a full education on the marketing and editing side of the television business. I spent my internship archiving old tapes, assisting in the edit bay, and helping the promotional spots go from idea to on the air. The entire process intrigued me but ultimately was not appealing enough to pursue after graduation. My internship allowed me to make great contacts in the marketing and on-air promotional space, learn a new side of the industry, and eventually decide that I didn’t want to do this on a daily basis. I was grateful to learn that lesson as an intern for ten weeks instead of as an entry-level employee.

May 06, 2012

A couple weeks ago I was at a fundraising committee meeting for a charitable organization when the chairman said we were starting the meeting with a word of prayer. As he prayed, he said something similar to this, "We know that the Bible says money is the root of all evil, but we still need to discuss it to help those who are hurting."

Uh, nope.

I didn't say anything because 1) this guy was the chairman, 2) he was an older guy (around 65 -- trying to respect my elders), 3) I am the "new guy" on the committee, and 4) it really didn't matter at the time anyway -- we didn't do anything differently based on what he said.

The often misquoted "money is the root of all evil" comes from 1 Timothy 6:10. But it leaves out three key words. Here's the actual verse from the New International Version:

For the love of money is a root of all kinds of evil. Some people, eager for money, have wandered from the faith and pierced themselves with many griefs.

Notice the difference?

Wrong: Money is a root of all kinds of evil.

Right: The love of money is a root of all kinds of evil. (my emphasis added)

So it's not that money is evil. Money is actually neutral and can be used for either good or ill. But it's the LOVE of money -- an all-consuming desire to get rich at any cost -- that causes people to do some pretty wacky things and make some poor choices. I think we could all list several examples of people we've known or read about who have fallen into this category.

Of course, there's another perspective. Here's a quote attributed to George Bernard Shaw:

Lack of money is the root of all evil.

:)

There's no doubt that not having enough has also caused people to take some less than praiseworthy actions. So there's some truth in this as well.

So where does this leave us? IMO money is something that should be accumulated and used for good -- the good of caring for one's own family, the good of helping others, and the good of enjoying life. It shouldn't be LOVED (because that can lead you down the wrong path), but it should be USED (to accomplish your life goals).

May 05, 2012

Crafting portfolio asset allocations is a combination of art and engineering. Just as a blending of colors can produce cerulean, so a blending of indexes produces a unique shade of risk and return. And these blended portfolios can be better than any of their components.

Many investors don't appreciate asset allocation or understand intuitively how a diversified portfolio can exceed the sum of its parts. After all, the capital asset pricing model (CAPM) suggests that return follows risk, and therefore you can't increase return and reduce risk at the same time. But CAPM is just a straight-line projection. And at the efficient frontier, the math produces nothing but curves.

The efficiency of an investment is measured by the greatest return for the lowest volatility. Blending a portfolio allocation can make it even more efficient by either boosting returns or lowering volatility.

To understand the math behind blended returns, let's start with a simple case of two investment choices and two years. Investment A goes up 30% the first year and 0% the second year. Investment B goes up 0% the first year and 30% the second year. If you invest in either A or B, you get a 30% return over two years. Your average volatility is 15%.

It seems no matter how you mix these two investments, you can't get more than a 30% return over two years. But you can. And you can lower your volatility as well.

Imagine a blended portfolio of half invested in A and half invested in B. The first year you would experience a 15% return, and the second year a 15% return. Your volatility would be 0%. Lower volatility means a more efficient portfolio.

You would have both lower volatility and higher returns. Compounding returns would produce a total return over the two years of 32.5%. You experience a higher return because after half of your portfolio invested in A grows by 30% the first year, you rebalance your portfolio. So half of the growth from investment A is rebalanced and put into investment B. Half the growth would experience another 30% growth the second year when investment B did better. Thus your total return for the two years would be 32.5%.

Most investors are surprised that by creating a blended portfolio and rebalancing regularly, you can both lower volatility and boost returns. But this is the math behind modern portfolio theory (MPT) developed in the 1950s by Harry Markowitz.

MTP requires knowing the average return and standard deviation of returns for each investment component. This situates each component on the risk-return grid. To look at the effects of blending these two investments together, MPT also entails knowing how much they move in sync with one another. This measurement is called the correlation coefficient. Two asset categories that move completely together have a correlation of +1.0. If they move completely opposite, their correlation is -1.0.

The lower the correlation, the greater the benefit of blending two different indexes in a portfolio. Asset allocation means dividing your portfolio into components that do not move completely in sync with one another to reduce total portfolio volatility. There is also a rebalancing that is a function of low correlation and high volatility.

We use historical correlation measurements to help define what qualifies as an asset class and what is simply a sector or subsector. If historical correlations are low enough, we separate two indexes into different asset classes. Otherwise they are just sectors or subsectors within an asset class.Once you know the average return, the standard deviation of each index and the correlation coefficient between each pair of indexes, the rest is math. The difficulty is that these measurements vary every year and every decade. Long-term averages are useful guidelines, but there are no guarantees.

If long-term measurements put an index just off the efficient frontier, it should not be eliminated entirely. We consider an investment close to the efficient frontier equivalent to one that historically was clearly there. Perhaps the next decade will be its turn to shine.

Most of the time portfolio gains from rebalancing are small at about 1.6% annually. But there are historical periods, especially choppy volatility ones, when the rebalancing bonus is significant enough to bend the mix of a blended portfolio well above either component by itself.

Placing asset categories on the efficient frontier requires knowing their historical average return and standard deviation. These numbers vary depending on the period of time being measured. If you measure risk and return during a time period in which one asset category did poorly, that category will not appear on the efficient frontier. However, if it happened to do well with little volatility during the time measured, it might dominate portfolio construction.

The math is only as good as the assumptions. And the assumptions can only be measured exactly by looking backward at historical returns. But past performance is no guarantee of future returns, which is why portfolio construction is part engineering and part art. There are assumptions to be made. Engineering can suggest elegant answers or art can be crafted with engineering precision, but nothing is guaranteed.

The efficient frontier is the blending of all possible components into portfolios with the highest possible return and the lowest possible volatility. Diversification means you always have something to complain about. But it also allows investors to craft allocations that are along the efficient frontier, getting the most return for the least volatility.

May 04, 2012

The following is the latest post in my "Reader Profiles" series. Each post in this series details the financial situation and challenges of an FMF reader. The purpose of this series is to help us all identify with people like us (in similar situations -- not all will be, of course, but eventually I'm sure you will find someone like you here), get to know the frequent commenters on the site, and hear some financial wisdom/challenges from people other than me.

If you're interested in contributing to this series, then drop me an email. The series seems to be very popular with readers and I need a steady stream of new ones to keep it going.

Next in the series is FMF reader WW. He answered my questions (in red below) as follows:

Please tell us a bit about yourself.

I’m in my early thirties, married (just 2 months ago), and work in consulting. I grew up in the West, attended a small private university in the Northeast for free due to scholarships ($130k worth of tuition) and so graduated with no debt. I’m happy I had the freedom to get a true liberal arts education, as I’ve been able to apply ideas from the various disciplines to completely unrelated areas of my life. My wife emigrated to the U.S. in her teens and attended an Ivy school, and we met through working in the same industry. I have lived in 5 different countries, and have had the opportunity to travel to 50 or so more for both work and pleasure. I feel very fortunate to have been able do this, as well as to have found my wonderful wife. We’re both grateful for the opportunities we’ve had in life and certainly don’t take what we have and our experiences for granted.

Describe your financial situation (who works in your family, how your income is (general), how your expenses are, etc.).

Currently, my wife and I both work. Our monthly income pre-tax is ~$25k, which according to a post on FMF puts us in about the top 3% in terms of income. My wife makes slightly more than me, which I’m quite happy about, and would be even happier if she were sizably outpacing me. Our income has grown steadily over the years, but only in the last few years did either of us hit 6 figures individually. The last couple of years and this year we will max out our 401(k)s as well as Roth IRAs (contributing via back door conversion). We also both have company stock plans that allow discounted stock purchases, which we buy the maximum of $30k combined each year. This is generally sold immediately so as to diversify stock holdings from the companies providing the paychecks. We’re just settling into married life, so it remains to be seen how much we’ll save in taxable accounts outside of what’s already mentioned. We live in the Bay Area for work opportunities and to be close to family. Currently, rent is $3k, utilities and such run ~$300 a month. We also pay a mortgage for my wife’s parents at $1,500 a month. Our income allows us to be more lax on other budget items; I have no idea how much we spend on food, gas, etc. per month and I generally don’t care. Giving is variable, but has probably averaged $20k a year the last few years (taking advantage of giving appreciated shares when possible).

Our wedding was great, but it ended up costing substantially more than I would have liked (about $35k in total). We’re far and away in the best shape financially in our families, so we provided a lot in terms of flights, hotels, and meals for other people that ballooned the cost. I negotiated everything vigorously and the actual ceremony and reception were probably ~$20k. We also went on a very nice long honeymoon that cost us ~$15k, but I regard as well worth it since we got to do things that we likely won’t get to do again in our lives.

A few years back I kept a budget and for 6 months I recorded every penny I spent; it turns out I was already spending on things that made me happy and there wasn’t a lot of waste, so I stopped with it. We don’t carry any monthly credit card debt, my wife has long since paid off her student loans, our cars are both paid for, and we don’t carry any other debt currently.

What are the current financial issues you're facing (saving, paying off debt, etc.)?

Our net worth is ~$1M. Roughly half of this is in retirement accounts with the other half in taxable accounts. Our assets are currently in stocks (40%), bonds (10%) and cash/short term instruments (50%). We have the cars and some other hard assets but I don’t regard these as significant to our overall financial picture. There are two issues facing us currently.

The first is whether to buy a place to live or not. A nice 2 bedroom place with good schools would run upwards of $800k in this area, unless we want our commutes to swell to 1-1.5 hours, which I regard as an unacceptable lowering of quality of life. This would obviously require a significant portion of our net worth and future income tied up in a mortgage. As mentioned, I have lived in several countries in the last 10+ years, and it’s been great to have the flexibility that comes with renting to be able to move around. Being married and likely needing more stability changes this, but I’ve found it hard to change that mindset in myself that owning a place would be like an anchor on me both financially and geographically. Owning both real estate and a mortgage could also be a helpful hedge against inflation, which is my next issue.

The other thing we’re currently facing is what is happening with the broader macroeconomic picture, and how to best position our money to continue growing our net worth (saving is a given). Being a net creditor, I would love some solid deflation or increase in strength of the dollar, but neither of those is going to happen with the current system in place. I’m very worried about the purchasing power of our savings being inflated away by the government and Fed – I don’t think there’s any other option for them, as the U.S. economy is never going to generate enough growth to bring down the debt, and the politicians will continue business as usual (deficit spending) until a collapse/crisis (see Europe for example A, which is far from over). Everyone likes to claim “this time it’s different!”, but it’s my belief that we are in the midst of something very different from our usual business cycle recession, this is a once-every-other generation deleveraging cycle that is far from over. It’s unlikely but possible (I’m giving it a 10% chance or so) that our current system is unsustainable that we’ll see a significant issue with the dollar in the next few years. Even without this, the low interest rate / growth environment make it difficult to keep ahead of inflation (even the low official number).

Clearly, this doesn’t square with having such a large cash position currently, but it illustrates one of the “tough” parts of being near, but not at the top of wealth. The very wealthy are connected enough that if something is about to go down, they get a call to clear out from those on the inside. No one from Goldman will ever be giving me a call. I have to either a) figure out my own strategy for protecting and growing wealth in a very difficult environment, or b) pay someone better than me to do so. I’m not convinced the people who would be willing to work with an investor of my size are any better at this than me, or at least my potential for being a good investor.

Along with bond prices being at an all-time high, corporate profits at an all-time high, real estate not yet returned to long-term norms, and who knows what in the precious metals market; it is a very, very challenging environment to invest in right now (I particularly liked Bill Gross’s description in his letter at the start of the year around two very divergent potential paths) and I find the need to become much more educated and diligent as an investor. I’ve not yet figured out what is the driving force, but the benefits of asset diversification have significantly dropped since 2007 (more correlation between classes), further complicating matters. So I’m trying to update my skills and figure out a comprehensive strategy currently, as I don’t like my old one and realize lacking one is not going to be sustainable for any period of time.

At the boundaries investing is easy; if I’m 22 and have $10k to invest I just put it in the Vanguard Total Stock and forget it. If I’m Old Limey and already rich and retired I just put it all in muni bonds and forget it. In between, though, it’s difficult to figure out the optimal or even near optimal strategy for maximizing growth and minimizing risk. I know FMF is in a similar situation and chooses to buy and hold index funds in the stock market. Which has worked great for a lot of people in the past, but I don’t regard as a particularly good strategy going forward as the market is changing in terms of technology, who’s invested, and the very different macro picture now vs. over the last 40 years.

I’ve learned a lot here from Tyler, Mike Hunt, Old Limey, and lots of others, so thank you all for sharing.

What are your plans for the future (retire early, build your career, etc.)?

I feel having ~$4M net worth in today’s dollar purchasing power is the “right” number for us to be free from working and throw off enough income to not ever touch principle while living a pretty great lifestyle. If we want to get there soon, it’s going to take investment gains more so than savings just because of the math with bigger numbers (saving an additional $20k a year only increases a $2M portfolio 1%), which is going to mean being on the winning side of some significant bets or being exceedingly lucky.

I realize that this is higher than most people shoot for, but for me money = freedom of action and time, both of which I value very highly. When I was 21 I was diagnosed with a terminal illness and given 2 years to live. It turned out to be an incorrect diagnosis; and while that period was certainly awful, it did give me a full appreciation for every day I have here, and resulted in a strange mix of living for the moment and immediate gratification with long-term saving goals to become wealthy enough to not have to spend any minutes doing work I don’t want to do. It also has made my risk tolerance nearly off the charts – as long as the reward matches or exceeds it I’m willing to take the gamble.

I used to be a buy-and-holder in the stock market, but I’ve updated my thinking based on additional research. There are lots of sources of material, but a particularly influential book for me was “Unveiling the Retirement Myth” by Jim Otar, which I actually only read because it was a free ebook download one day (maybe mentioned on FMF?). There are a few minor quibbles with the book, but on the whole he takes a great approach to the math and conventional wisdom of personal finance and I think a lot of the crowd here would really appreciate it; it’s a lot better than most of the personal finance canon.

Philosophically, my viewpoint on personal finances is just a part of my larger view of life. You have to determine what your priorities are, and then take action based on that. For example, a lot of people in my company say things like “I wish I could live overseas like you did…”, when in fact they could. They just aren’t willing to make the tradeoffs necessary, or haven’t prioritized it highly enough. I personally value friends and family, my health, and having free time to travel, hike, or pursue other activities I enjoy. My personal finances reflect these as I spend my money on these things (and virtually nothing else) and invest so I can do more of them in the future.

Figure out what you really value in life, and spend your money and time there, whether you have a lot or a little. It doesn't have to be that hard.